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MTC, Canada and Northeast State Developments
MTC, Canada and Northeast State Developments April 2015 MTC Audits Canada Connecticut Delaware District of Columbia Maine Maryland Massachusetts New Hampshire New Jersey New York Pennsylvania Rhode Island Vermont COST 2015 SPRING AUDIT SESSION LIST OF STATE DEVELOPMENT CONTRIBUTORS As of April 17, 2015 COST would like to express their appreciation to the state tax attorneys who contributed to the items contained in the State Development Update. Such items should not be construed as legal advice, and taxpayers are encouraged to contact local counsel when considering the impact of the procedural and/or substantive items contained herein. 2015 Copyright Council On State Taxation – All Rights Reserved 1 ALABAMA STATE DEVELOPMENTS Bruce P. Ely ([email protected]) Christopher R. Grissom ([email protected]) James E. Long, Jr. ([email protected]) William T. Thistle II ([email protected]) BRADLEY ARANT BOULT CUMMINGS LLP One Federal Place, 1819 Fifth Avenue North Birmingham, Alabama 35203 205.521.8000 www.babc.com ALASKA STATE DEVELOPMENTS Robert (Bob) Mahon PERKINS COIE LLP 1201 Third Avenue, Suite 4800 Seattle, WA 98101 Tel. (206) 359-6360 Fax (206) 359-7360 Email: [email protected] www.perkinscoie.com ARIZONA STATE DEVELOPMENTS Jeffrey M. Vesely, Esq. ((415) 983-1075) [email protected] Kerne H. O. Matsubara, Esq. ((415) 983-1233) [email protected] Annie H. Huang, Esq. ((415) 983-1979) [email protected] Michael J. Cataldo, Esq. ((415) 983-1954) [email protected] PILLSBURY WINTHROP SHAW PITTMAN LLP P.O. Box 2824 San Francisco, CA 94126 ARKANSAS STATE DEVELOPMENTS Michael O. Parker, Esq. ([email protected]) Thane J. Lawhon, Esq. ([email protected]) DOVER DIXON HORNE PLLC 425 West Capitol, 37th Floor Little Rock, AR 72201 Phone: (501)375-9151 Fax: (501)372-7142 Website: www.ddh-ar.com CALIFORNIA STATE DEVELOPMENTS Jeffrey M. Vesely, Esq. (415) 983-1075 [email protected] Annie H. Huang, Esq. (415) 983-1979 [email protected] Kerne H. O. Matsubara, Esq. (415) 983-1233 [email protected] PILLSBURY WINTHROP SHAW PITTMAN LLP P.O. Box 2824 San Francisco, CA 94126 COLORADO STATE DEVELOPMENTS Not provided. CONNECTICUT STATE DEVELOPMENTS Charles H. Lenore DAY PITNEY LLP 242 Trumbull Street Hartford, CT 06103-1212 Phone: (860) 275-0119 Fax: (860) 881-2438 Email: [email protected] Company Website: www.daypitney.com DELAWARE STATE DEVELOPMENTS Not provided. DISTRICT OF COLUMBIA DEVELOPMENTS Kenneth H. Silverberg [email protected] Christian M. McBurney [email protected] Robert G. Trott [email protected] NIXON PEABODY LLP 401 – 9th Street, NW #900 Washington, DC 20004-2128 202-585-8000 website: http://www.nixonpeabody.com DISTRICT OF COLUMBIA DEVELOPMENTS Donald M. Griswold, Esq. ([email protected]) Walter Nagel, Esq. ([email protected]) Jeremy Abrams, Esq. ([email protected]) CROWELL & MORING LLP 1001 Pennsylvania Ave., N.W. Washington, D.C. 20004 Phone: (202) 624-2500 Fax: (202) 628-5116 Web: http://www.crowell.com/statetax FLORIDA STATE DEVELOPMENTS Jim Ervin HOLLAND & KNIGHT LLP 315 Calhoun Street, Suite 600 Tallahassee, FL 32301 Phone: 850/425-5649 Office Email: [email protected] Company Website: www.hklaw.com FLORIDA STATE DEVELOPMENTS Mark E. Holcomb, Esq. MADSEN GOLDMAN & HOLCOMB, LLP 1705-01 Metropolitan Blvd. Tallahassee, FL 32308 Ph. 850.523.0400 Fax 850.523.0401 [email protected] www.mgh-law.com 2 GEORGIA STATE DEVELOPMENTS John Allan, J.D., C.P.A. ([email protected]) (404) 581-8012 Mace Gunter, J.D. ([email protected]) (404) 581-8256 Eric Reynolds, J.D., C.P.A. ([email protected]) (404) 581-8669 JONES DAY 1420 Peachtree Street, N.E., Suite 800 Atlanta, GA 30309 (404) 581-8330 (fax) HAWAII STATE DEVELOPMENTS Miki Okumura ([email protected]) Telephone: (808) 547-5758 Karyn R. Okada ([email protected]) Telephone: (808) 547-5845 GOODSILL ANDERSON QUINN & STIFEL LLP 999 Bishop Street, Suite 1600 Honolulu, Hawaii 96813 Fax: (808) 547-5880 IDAHO STATE DEVELOPMENTS Robert T. Manicke ([email protected]) Kris J. Ormseth ([email protected]) Dustin R. Swanson ([email protected]) STOEL RIVES LLP 101 S. Capitol Blvd., Ste. 1900 Boise, ID 83702-7705 Phone: (208) 389-9000 Fax: (208) 389-9040 www.stoel.com IDAHO STATE DEVELOPMENTS Kirk Lyda JONES DAY 2727 North Harwood St. Dallas, TX 75201 1.214.969.5013 [email protected] http://www.jonesday.com/klyda/ IDAHO STATE DEVELOPMENTS Robert (Bob) Mahon PERKINS COIE LLP 1201 Third Avenue, Suite 4800 Seattle, WA 98101 Tel. (206) 359-6360 Fax (206) 359-7360 Email: [email protected] www.perkinscoie.com ILLINOIS STATE DEVELOPMENTS Thomas H. Donohoe Jane Wells May Fred M. Ackerson Catherine A. Battin Mary Kay Martire Matthew C. Boch Lauren A. Ferrante MCDERMOTT WILL & EMERY LLP 227 West Monroe Street Chicago, Illinois 60606 (312) 372-2000 www.mwe.com www.InsideSALT.com ILLINOIS STATE DEVELOPMENTS Michael J. Wynne ([email protected]) 312.207.3894 Adam P. Beckerink ([email protected]) 312.207.6528 Jennifer C. Waryjas ([email protected]) 312.207.6470 Douglas A. Wick ([email protected]) 312.207.2830 REED SMITH LLP 10 South Wacker Drive Chicago, IL 60606 312.207.6400 (Facsimile) INDIANA STATE DEVELOPMENTS Francina A. Dlouhy1 FAEGRE BAKER DANIELS LLP 300 N. Meridian Street, Suite 2700 Indianapolis, IN 46204 Tel: (317) 237-1210 Fax: (317) 237-1000 Email: [email protected] www.FaegreBD.com IOWA STATE DEVELOPMENTS John Allan, J.D., C.P.A. ([email protected]) (404) 581-8012 Mace Gunter, J.D. ([email protected]) (404) 581-8256 Eric Reynolds, J.D., C.P.A. ([email protected]) (404) 581-8669 JONES DAY 1420 Peachtree Street, N.E., Suite 800 Atlanta, GA 30309 (404) 581-8330 (fax) 3 KANSAS STATE DEVELOPMENTS S. Lucky DeFries ([email protected]) Jeffrey A. Wietharn ([email protected]) COFFMAN, DEFRIES & NOTHERN, P.A. 534 S. Kansas Ave., Suite 925 Topeka, KS 66603-3407 Phone: (785) 234-3461 Fax: (785) 234-3363 Company Website: www.cdnlaw.com KENTUCKY STATE DEVELOPMENTS Timothy J. Eifler ([email protected]) Direct Dial: (502) 560-4208 Stephen A. Sherman ([email protected]) Direct Dial: (502) 568-5405 Stoll Keenon Ogden PLLC 500 West Jefferson Street, Suite 2000 Louisville, KY 40202 Erica L. Horn ([email protected]) Direct Dial: (859) 231-3037 Jennifer S. Smart ([email protected]) Direct Dial: (859) 231-3619 STOLL KEENON OGDEN PLLC 300 West Vine Street, Suite 2100 Lexington, KY 40507 LOUISIANA STATE DEVELOPMENTS William M. Backstrom, Jr. JONES WALKER LLP 201 St. Charles Ave., Suite 5100 New Orleans, LA 70170-5100 Phone: 504-582-8228 Email: [email protected] Firm Website: www.joneswalker.com Jones Walker SALT Twitter: @JonesWalkerSALT Jones Walker SALT Blog: www.cookingwithSALTlaw.com MAINE STATE DEVELOPMENTS Sarah H. Beard, Esq. PIERCE ATWOOD LLP Merrill’s Wharf 254 Commercial Street Portland, ME 04101 [email protected] (207) 791-1378 MARYLAND STATE DEVELOPMENTS Alexandra E. Sampson, Esq. REED SMITH LLP 1301 K Street, NW, Suite 1000 – East Tower Washington, D.C. 20005 Phone: 202-414-9486 Fax: 202-414-9299 Email: [email protected] MARYLAND STATE DEVELOPMENTS Kenneth H. Silverberg ([email protected]) Christian M. McBurney ([email protected]) Robert G. Trott ([email protected]) NIXON PEABODY LLP 401 – 9th Street, NW #900 Washington, DC 20004-2128 202-585-8000 202-585-8080 facsimile website: http://www.nixonpeabody.com MASSACHUSETTS STATE DEVELOPMENTS Michael A. Jacobs ([email protected]) Phone: 215-851-8868 Robert E. Weyman ([email protected]) Phone: 215-851-8160 Brent K. Beissel ([email protected]) Phone: 215-851-8869 REED SMITH LLP Three Logan Square 1717 Arch St., Ste. 3100 Philadelphia, PA 19103 MICHIGAN STATE DEVELOPMENTS Patrick Van Tiflin, Esq., Chair, SALT Practice Group [email protected] Telephone: (517) 377-0702 Fax: (517) 364-9502 Daniel Stanley, Esq., Partner, SALT Practice Group [email protected] Telephone: (517) 377-0714 Fax: (517) 364-9514 HONIGMAN MILLER SCHWARTZ AND COHN LLP The Phoenix Building, Suite 400 222 North Washington Square Lansing, MI 48933-1800 MINNESOTA STATE DEVELOPMENTS Jerry Geis BRIGGS AND MORGAN, P.A. W-2200 First National Bank Building Saint Paul, Minnesota 55101 (651) 808-6409 [email protected] MISSISSIPPI STATE DEVELOPMENTS Louis G. Fuller BRUNINI, GRANTHAM, GROWER & HEWES, PLLC 190 East Capitol Street, Suite 100 Jackson, Mississippi 39201 P. O. Drawer 119, Jackson, Mississippi 39205 Phone: (601) 948-3101 / Direct: (601) 960-6874 FAX: (601) 960-6902 E-mail: [email protected] Website: www.brunini.com 4 MISSOURI STATE DEVELOPMENTS Janette M. Lohman [email protected] P: 314.552.6161 F: 314.552.7161 M: 314.602.6161 THOMPSON COBURN LLP One US Bank Plaza St. Louis, MO 63101 www.thompsoncoburn.com MONTANA STATE DEVELOPMENTS Michael Green Wiley Barker CROWLEY FLECK PLLP P.O. Box 797 Helena, MT 59624 Phone: (406) 449-4165 Fax: (406) 449-5149 Website: www.crowleyfleck.com NEBRASKA STATE DEVELOPMENTS Kirk Lyda JONES DAY Dallas 1.214.969.5013 [email protected] http://www.jonesday.com/klyda/ NEVADA STATE DEVELOPMENTS Kirk Lyda JONES DAY Dallas 1.214.969.5013 [email protected] http://www.jonesday.com/klyda/ NEW HAMPSHIRE STATE DEVELOPMENTS William F. J. Ardinger Christopher J. Sullivan Kathryn H. Michaelis Stanley R. Arnold RATH, YOUNG AND PIGNATELLI, P.C. One Capital Plaza Concord, NH 03301 Phone: 603.226.2600 E-Mail: [email protected] Web Site: www.rathlaw.com NEW JERSEY STATE DEVELOPMENTS Kyle O. Sollie ([email protected]) Phone: 215-851-8852 / Phone: 215-499-6171 David J. Gutowski ([email protected]) Phone: 215-851-8874 / Phone: 609-524-2028 Robert E. Weyman ([email protected]) Phone: 215-851-8160 REED SMITH LLP Three Logan Square 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 NEW MEXICO STATE DEVELOPMENTS Not provided. NEW YORK STATE DEVELOPMENTS Not provided. NORTH CAROLINA STATE DEVELOPMENTS Charles B. Neely, Jr. ([email protected]) Nancy S. Rendleman ([email protected]) Eugene W. Chianelli, Jr. ([email protected]) WILLIAMS MULLEN P.O. Box 1000 Raleigh, NC 27602 Telephone 919-981-4000 Telecopier 919-981-4300 Website: www.williamsmullen.com NORTH DAKOTA STATE DEVELOPMENTS Michael Green Wiley Barker CROWLEY FLECK PLLP P.O. Box 797 Helena, MT 59624 Phone: (406) 449-4165 Fax: (406) 449-5149 Website: www.crowleyfleck.com NORTH DAKOTA STATE DEVELOPMENTS Kirk Lyda JONES DAY Dallas 1.214.969.5013 [email protected] http://www.jonesday.com/klyda/ OHIO STATE DEVELOPMENTS Anthony L. Ehler ([email protected]) (614) 464-6400 (614) 464-6350 (fax) John S. Petzinger (614) 464-5696 (614) 719-4996 (fax) VORYS, SATER, SEYMOUR AND PEASE LLP 52 East Gay Street P O Box 1008 Columbus, Ohio 43216-1008 www.vorys.com OKLAHOMA STATE DEVELOPMENTS Sheppard F. Miers, Jr. GABLE GOTWALS 100 West Fifth Street, Suite 1100 Tulsa, Oklahoma 74103-4217 918-595-4834, Fax 918-595-4990 [email protected] 5 OKLAHOMA STATE DEVELOPMENTS Kirk Lyda JONES DAY 2727 North Harwood Street Dallas, Texas 75201 1.214.969.5013 [email protected] http://www.jonesday.com/klyda/ OREGON STATE DEVELOPMENTS Robert T. Manicke ([email protected]) Eric J. Kodesch ([email protected]) STOEL RIVES LLP 900 SW Fifth Avenue, Suite 2600 Portland, Oregon 97204-1268 Ph: (503) 224-3380 Fax: (503) 220-2480 www.stoel.com PENNSYLVANIA STATE DEVELOPMENTS Lee A. Zoeller ([email protected]) Phone: 215-851-8850 Frank J. Gallo ([email protected]) Phone: 215-851-8860 Christine M. Hanhausen ([email protected]) Phone: 215-851-8865 REED SMITH LLP Three Logan Square, Suite 3100 1717 Arch Street Philadelphia, PA 19103 RHODE ISLAND STATE DEVELOPMENTS Kirk Lyda JONES DAY 2727 North Harwood Street Dallas, TX 75201 (214) 969-5013 [email protected] http://www.jonesday.com/klyda/ SOUTH CAROLINA STATE DEVELOPMENTS John C. von Lehe, Jr. NELSON MULLINS RILEY & SCARBOROUGH LLP PO Box 1806 Charleston, SC 29402 (843) 534-4311 (843) 534-4349 (fax) [email protected] www.nelsonmullins.com SOUTH DAKOTA STATE DEVELOPMENTS Patrick G. Goetzinger & Andrew J. Knutson GUNDERSON, PALMER, NELSON & ASHMORE, LLP P.O. Box 8045, Rapid City, SD 57709-8045 Tel. 605-342-1078 Fax: 605-342-9503 E-Mail Addresses: [email protected]; [email protected] Website: www.gundersonpalmer.com TENNESSEE STATE DEVELOPMENTS Joseph W. Gibbs ([email protected]) Patricia Head Moskal ([email protected]) Brett R. Carter ([email protected]) Brian S. Shelton ([email protected]) BRADLEY ARANT BOULT CUMMINGS LLP 1600 Division Street, Suite 700 Nashville, TN 37203 615.244.2582 www.babc.com TEXAS STATE DEVELOPMENTS Kirk Lyda JONES DAY 2727 North Harwood St. Dallas, TX 75201 (214) 969-5013 [email protected] www.jonesday.com/klyda UTAH STATE DEVELOPMENTS Mark K. Buchi Steven P. Young Nathan R. Runyan John T. Deeds Pamela B. Hunsaker HOLLAND & HART, LLP 222 South Main Street, Suite 2200 Salt Lake City, Utah 84101 Tel: (801) 799-5800 Fax: (801) 799-5700 Website: www.hollandhart.com VERMONT STATE DEVELOPMENTS Kathryn H. Michaelis ([email protected]) William F.J. Ardinger ([email protected]) Christopher J. Sullivan ([email protected]) Stan Arnold ([email protected]) RATH, YOUNG AND PIGNATELLI, P.C. One Capital Plaza Concord, NH 03301 Phone: 603.226.2600 Web Site: www.rathlaw.com VIRGINIA STATE DEVELOPMENTS William L. S. Rowe ([email protected]) Rita Davis ([email protected]) Emily J. S. Winbigler ([email protected]) HUNTON & WILLIAMS LLP 951 East Byrd Street Richmond, Virginia 23219 6 VIRGINIA STATE DEVELOPMENTS Michael A. Jacobs ([email protected]) Phone: 215-851-8868 Daniel M. Dixon ([email protected]) Phone: 215-851-8160 Michael I. Lurie ([email protected]) Phone: 215-241-5687 REED SMITH LLP Three Logan Square 1717 Arch St Philadelphia, PA 19103 WYOMING STATE DEVELOPMENTS Michael Green Wiley Barker CROWLEY FLECK PLLP P.O. Box 797 Helena, MT 59624 Phone: (406) 449-4165 Fax: (406) 449-5149 Website: www.crowleyfleck.com VIRGINIA STATE DEVELOPMENTS Donald M. Griswold, Esq. ([email protected]) Walter Nagel, Esq. ([email protected]) Jeremy Abrams, Esq. ([email protected]) CROWELL & MORING LLP 1001 Pennsylvania Ave., N.W. Washington, D.C. 20004 Phone: (202) 624-2500 Fax: (202) 628-5116 Web: http://www.crowell.com/statetax WASHINGTON STATE DEVELOPMENTS Robert (Bob) Mahon ([email protected]) Tel. (206) 359-6360 / Fax (206) 359-7360 Gregg Barton ([email protected]) Tel. (206) 359-6358 / Fax (206) 359-7358 PERKINS COIE LLP 1201 Third Avenue, Suite 4900 Seattle, WA 98101 www.perkinscoie.com WEST VIRGINIA STATE DEVELOPMENTS Michael E. Caryl, Esquire BOWLES RICE LLP 101 South Queen Street Post Office Box 1419 Martinsburg, West Virginia 25402 Telephone: (304) 364-4225 Facsimile: (304) 267-3822 e-Mail: [email protected] www.bowlesrice.com WISCONSIN STATE DEVELOPMENTS Carl D. Fortner ([email protected]) Timothy L Voigtman ([email protected]) Theresa A. Nickels ([email protected]) Eric J. Hatchell ([email protected]) FOLEY & LARDNER LLP 777 East Wisconsin Avenue Milwaukee, WI 53202-5367 Tel: 414-297-5739 [CDF] 414-297-5677 [TLV] 608-258-4235 [TAN] 608-258-4270 [EJH Fax: 414-297-4900 Website: www.foley.com 7 March 3, 2015 CONNECTICUT STATE DEVELOPMENTS Charles H. Lenore Day Pitney LLP 242 Trumbull Street Hartford, CT 06103-1212 Phone: (860) 275-0119 Fax: (860) 881-2438 Email: [email protected] Company Website: www.daypitney.com I. INCOME/FRANCHISE TAXES A. Legislative Developments Governor Malloy (D) has proposed several significant corporate tax increases in his biennial budget for fiscal years 2016 and 2017 (July 1, 2015 – June 30, 2017). These proposals will now be taken up by the General Assembly, which is in session through June 3, 2015. The Governor proposed making permanent the 20% surcharge on the Corporation Business Tax rate of 7.5%, which yields a rate of 9%. The surcharge, which is now in its fourth year, currently is scheduled to expire at the end of 2015. The 20% surcharge on the capital base tax and the minimum tax also would become permanent. Additionally, the Governor proposed lowering the cap on the maximum amount of credits that could be used against a taxpayer’s Corporation Business Tax liability from its current limit of 70% to 35% for 2015, 45% for 2016 and 60% thereafter. No provision has been made to extend credits that might expire before utilization due to this new lower limit. Similarly, the 35% limit on the use of credits against the Insurance Premiums Tax would be extended through 2016. That limit was supposed to return to its prior rate of 70% after 2014. The budget proposal also would cap the use of net operating losses at 50% of net income, beginning in 2015. This change also would be permanent. There were no tax increases or significant new taxes enacted during the 2014 legislative session, which was not surprising since 2014 was an election year. Legislation was enacted, however, calling for a comprehensive study of the Corporation Business Tax, the Sales and Use Tax, the Personal Income Tax, the Property Tax, the Estate and Gift Tax and various excise taxes. The report of the study panel is due by January 1, 2016. The panel has hired a consultant to provide technical expertise. As part of the budget for the fiscal year that will end on June 30, 2015, the Department of Revenue Services was given the responsibility for collecting an additional $75 million in tax revenue. The Department has begun a Corporation Business Tax collection initiative focused on transfer pricing between related entities, non-filers, and tax deficiencies remaining following the conclusion of the 2013 tax amnesty. As part of its effort to increase its auditing of transfer pricing arrangements, the Department hired Chainbridge Software LLC to provide training. B. Judicial Developments There were no judicial developments of note during the last year. C. Administrative Developments There were no administrative developments of note during the last year. II. 43433298.8 TRANSACTUAL TAXES A. Legislative Developments As part of his budget proposal for fiscal years 2016 and 2017, the Governor is proposing to reduce the Sales and Use Tax rate from 6.35% to 6.2% on November 1, 2015, and from 6.2% to 5.95% on April 1, 2017. In each case, the lower rate would be applicable to sales occurring on and after the effective date. To offset these rate reductions, the Governor is proposing to eliminate the exemption for clothing under $50 that was to take effect on July 1, 2015. His proposal also would alter the Sales Tax free week for footwear and clothing in August each year by reducing the exemption from $300 to $100 per item effective for 2015. As noted above, 2014 legislation provided for a comprehensive study of the State’s tax structure, including the Sales and Use Tax. Specific aspects of that tax likely to be considered include a comparison of the existing rate and exemptions to a lower rate and a broader base, and the treatment of business-to-business sales. Public Act 14-155, Section 14 accelerated the due date for Sales and Use Tax returns from the last day of the next succeeding month to the twentieth day of the next succeeding month. The provision took effect with respect to tax periods beginning on or after January 1, 2015. Accordingly, monthly returns for January, 2015 were due on February 20, 2015. Delinquent taxpayers may be required by the Department of Revenue Services to remit weekly. B. Judicial Developments There were no judicial developments of note during the last year. -243433298.8 C. Administrative Developments On July 30, 2014, the Department of Revenue Services released Special Notice 2014(3), which summarizes legislative changes to the Sales and Use Tax and other transactional taxes. On February 7, 2014, the Department issued Policy Statement 2014(1), which updates its 1999 policy statement setting forth the scope of, and procedure for claiming, the exemption for water pollution control equipment. III. PROPERTY TAXES A. Legislative Developments The Governor did not propose any property tax changes in his budget address. However, it is likely that the local property tax on automobiles, and the use of property tax to fund special education, each will be raised for debate this Session. The legislative tax study noted above also includes the local property tax, which is the only tax for which the legislation set out specific questions to be considered by the panel. The legislation requires the panel to “evaluate the feasibility of (A) creating a tiered property tax payment system that includes any property that is (i) stateowned, (ii) owned by an institution, facility or hospital and for which a payment in lieu of taxes has been made pursuant to section 12-20a of the general statutes, as amended by this act, or (iii) owned by a nonprofit entity, (B) assessing a community benefit fee upon any property that is not liable for the payment of property taxes, (C) taxing property owned by an institution, facility or hospital and for which a payment of taxes has been made pursuant to section 12-20a of the general statutes, and (D) requiring any such institution, facility or hospital to report the value of its real and personal property.” Public Act 14-174 established a pilot program in not more than five municipalities to allow for the assessment of commercial properties based on the net profits of the business occupying such property. The legislation was effective October 1, 2014, which is the annual assessment date. Public Act 14-174 also allows the City of Hartford to assess owner-occupied residential units at a lower rate than non-owner occupied residential units. That provision is effective October 1, 2016. B. Judicial Developments In Fairfield Merrittview Limited Partnership v. Norwalk, ___ Conn. ___ (App. Ct. April 15, 2014), the Connecticut Appellate Court held that the plaintiff lacked standing to maintain a property tax appeal as it was not the owner of the property on the assessment date. The appeal had been brought in the name of a former owner of the property, who later tried to join the current owner to the litigation as an additional plaintiff. -343433298.8 IV. OTHER TAXES Public Act 14-155 amended the Personal Income Tax to include as Connecticut source income (i) compensation from nonqualified deferred compensation plans attributable to services performed within the state, including compensation required to be included in Federal gross income under Section 457A of the Internal Revenue Code, and (ii) gains and losses from the disposition of an interest in a pass-through entity holding real property in Connecticut if the fair market value of such real estate exceeds fifty percent of the value of all of the assets of the entity. The provisions were retroactive to January 1, 2014, although Connecticut Regulation Section 12-711(b)-19 already provided for the sourcing of deferred compensation to Connecticut. Public Act 14-155 also changed the Personal Income Tax apportionment rules for sales of tangible personal property by pass-through entities from an origin basis to a destination basis to conform with the Corporation Business Tax, retroactive to January 1, 2014. No change was made, however, to the apportionment rules for passthrough entities relating to revenue from services. Public Act 14-47, Section 51, extended the Personal Income Tax credit for “angel investors” under C.G.S. Section 12-704d through June 30, 2016. The credit originally was to expire on June 30, 2014. In Adams v. Commissioner, CV-11-0611324 (July 24, 2014), the Tax Court held that an individual’s deduction for net operating losses under the Personal Income Tax was limited to the amount of that individual’s taxable income under the Federal Income Tax. V. BIOGRAPHY/RESUME Charlie Lenore practices in the area of state and federal tax law. Charlie’s tax practice includes Connecticut tax matters, on which he is a well-known speaker and author. In addition to tax planning and counseling, Charlie has extensive experience litigating tax cases before the Connecticut Tax Court and the Connecticut Supreme Court, and has served on several taskforces established by the Connecticut General Assembly and the Department of Revenue Services on tax/policy initiatives. Charlie is the chair of the Tax Committee of the Connecticut Business and Industry Association. Charlie has assisted clients with several economic development projects with the State of Connecticut and municipalities. Funding mechanisms have included grants, loans, sales and tax use exemptions, property tax exemptions and PILOT payments, and tax credits. -443433298.8 DISTRICT OF COLUMBIA SALT DEVELOPMENTS ______________________________________________________________________________ KENNETH H. SILVERBERG CHRISTIAN M. MCBURNEY ROBERT G. TROTT NIXON PEABODY LLP 401 – 9th Street, NW #900 Washington, DC 20004-2128 202-585-8000 202-585-8080 facsimile [email protected] [email protected] website: http://www.nixonpeabody.com I. INCOME AND FRANCHISE TAXES A. Corporations, Financial Institutions, and Unincorporated Businesses 1. Estimated Tax Underpayment Penalty Replaced by Interest Only Regime Corporations, financial institutions, and unincorporated businesses are required to make quarterly estimated tax payments. D.C. Code § 47-4215(a). If adequate deposits were not made, the estimated tax penalty may apply. D.C. Code § 47-4215(c)(1). The penalty for these tax years is calculated by applying the underpayment interest rate (13 percent per year simple interest rate from January 1, 2001, to December 31, 2002; thereafter, 10 percent daily compounded rate) to the underdeposited quarterly payments. For tax years beginning after December 31, 2011, a business could avoid the underpayment penalty if, on a quarterly basis, it has paid the lesser of the amount required under the annualized income method set forth in D.C. Code § 47-4215(b)(2)(A) or 25 percent of the lesser of the following: i. 90 percent of the current year’s liability; or ii. 110 percent of the prior year’s liability (assuming prior year is 12 months). D.C. Code § 47-4215(c). For tax years beginning after December 31, 2011 and before December 31, 2014 no underpayment penalty will be imposed if the tax due is less than $1,000 or the taxpayer was in the District for the full prior year and did not have any tax liability for that year. D.C. Code § 47-4215(e). The penalty regime in preceding paragraphs of this section were repealed for tax years beginning after December 31, 2014, and are replaced by an interest-only regime. See Section 7131 of the Fiscal Year 2015 Budget Support Emergency Act of 2014. By not making the estimated tax a penalty, a corporate taxpayer can deduct such interest (in general, a taxpayer cannot deduct a government penalty). The same thresholds in (a) apply. D.C. Code § 47-4204. 15157249.1 -22. Apportionment L. 2015, Act 20-424 (Law 20-155), effective 02/26/2015 and applicable 10/01/2014 unless otherwise provided, enacts the “Fiscal Year 2015 Budget Support Act of 2014.” After December 31, 2014, business income will be apportioned to the District of Columbia using only the sales factor. For sales other than sales of tangible personal property, a sale is considered in the District of Columbia if the taxpayer's market for the sale is in the District. 3. Corporate and Unincorporated Business Franchise Tax Rate L. 2015, Act 20-424 (Law 20-155), effective 02/26/2015 and applicable 10/01/2014 unless otherwise provided, enacts the “Fiscal Year 2015 Budget Support Act of 2014.” The legislation sets the corporate and unincorporated business franchise tax rate at 9.4% for the taxable year beginning after December 31, 2014. B. Judicial Developments 1. Office of Administrative Hearings Grants Stay in Four Chainbridge Cases A District of Columbia (“District”) Office of Administrative Hearings (OAH) panel of judges granted stays in four transfer pricing cases, pending the outcome of three cases currently being appealed by the District that involve the same issues. Ruling in favor of the Office of Tax and Revenue (OTR) that petitioned the OAH, the panel cited judicial economy and efficiency as the reason for staying the cases. In Microsoft Corp. v. D.C. Office of Tax and Revenue, an earlier, unrelated case decided on April 23, 2012, Judge Paul Handy of the OAH struck down a $2.75 million assessment against Microsoft Corp., holding that the transfer pricing analysis on which the assessment was based was “useless in determining whether Microsoft's controlled transactions were conducted in accordance with the arm's length standard.” Judge Handy’s ruling is the impetus for the resulting showdown between the OTR and the Chainbridge taxpayers that led to the January 21, 2015 stays ordered by the OAH. At the heart of the disagreement is whether the doctrine of collateral estoppel binds the OTR to the OAH ruling in Microsoft. The Chainbridge Cases involve challenges by ExxonMobil of a $2.86 million assessment, Hess of a $910,635 assessment, and Shell of a $697,523 assessment, which resulted from Chainbridge Software’s application of federal transfer pricing regulations. The taxpayers’ claim Chainbridge failed to properly recognize related-party transactions and also relied on improper comparables. During an August 27, 2014, OAH hearing, Hess, ExxonMobil, and Shell argued that the assessments brought against them were all based on the same type of report using the same previously invalidated method struck down in Microsoft. As such, they argued that Judge Handy’s ruling was fully vetted and decided, and satisfied the requirements of the doctrine of collateral estoppel. The taxpayers supported their claim that collateral estoppel with the following: 15157249.1 -3i. the primary issue in the cases was litigated in Microsoft and the taxpayers are asserting the same claims presented in that case; ii. the parties in Microsoft had a full and fair opportunity to address the issues in the case at trial and on appeal, which the OTR initially pursued and then abandoned; iii. the Microsoft summary judgment order was a valid judgment on the merits of the case from which the OTR filed an appeal; and iv. the hearing office's decision was essential to the judgment and not mere dicta. The District argued collateral estoppel should not apply because a year after Handy’s ruling, Judge John M. Campbell of the D.C. Superior Court denied BP Products’ motion for summary judgment on the same issue, finding there were issues of fact that could only be decided at trial. (BP Prods. N. Am. v. District of Columbia, D.C. Super. Ct. No. 201cvt10619, settlement 1/28/14.) During the August 27, 2014 hearing, Administrative Law Judge Beverly Nash asked why an unpublished bench ruling on a motion for summary judgment in another court ought to carry weight in a matter before the OAH. The District responded that the facts and law are so intertwined in transfer pricing issues that it cannot be decided as a matter of law, and also that the decision to not appeal Microsoft was strategic and shouldn’t freeze all future cases on the issue at the trial level without recourse to appeal. The taxpayers countered that the growing caseload of similar cases is a good reason for doing exactly that, pointing to six additional cases that have already been filed and claiming that at least six other taxpayers intended to file suit on the same grounds. The taxpayers also argued that collateral estoppel was appropriate because Judge Handy’s decision explains exactly why Chainbridge Software’s method is arbitrary, capricious, and unreasonable. In three separate orders issued on November 14, 2014, Judge Nash overturned the assessments against ExxonMobil, Hess and Shell, ruling that the OTR is bound by Judge Handy’s earlier OAH ruling in Microsoft. Judge Nash said the doctrine of “nonmutual offensive collateral estoppel” precludes OTR from raising an issue that had been dealt with in an earlier case. The three cases currently under appeal and the four stayed cases all challenge OTR's use of contractor Chainbridge Software LLC to develop transfer pricing analyses. The four stayed cases are i. Ahold USA Holdings Inc. v. D.C. Office of Tax and Revenue, which challenges a tax assessment of $575,746.00 based on an income adjustment of $5.7 million; ii. AT& T Services Inc. v. D.C. Office of Tax and Revenue, which challenges a $4.3 million assessment based on an income adjustment of $43 million; iii. Eli Lilly and Co. v. D.C. Office of Tax and Revenue, which challenges a $506,771 assessment based on an income adjustment of $5 million; and 15157249.1 -4iv. ExxonMobil Oil Corp. v. D.C. Office of Tax and Revenue, which challenges a tax assessment of $207,964 based on an income adjustment of $2.08 million. At a Dec. 3 hearing, attorneys for OTR told a panel of four judges that the District strongly disagreed with Nash's determination and claimed the District would suffer serious complications if her ruling is allowed to stand. (234 DTR H-1, 12/5/14) If the District fails to successfully appeal Hess, ExxonMobil, and Shell, then the door would be open for other taxpayers seeking to challenge OTR assessments on similar grounds. Nash and Handy represented two of the four judges on the panel. Taxpayers assessed based on an analysis by Chainbridge Software, or a method similar to Chainbridge’s or that invalidated in Microsoft, should consider filing protective claims, pending the outcome of the current litigation. II. ADMINISTRATIVE 1. Exclusion from Definition of Unincorporated Business For tax years beginning after December 31, 2014, a trade or business that arises solely by reason of the purchase, holding, or sale of, or entering, maintaining or terminating of positions in stocks, securities, or commodities for a taxpayer’s own account is expressly excluded from the definition of an unincorporated business. D.C. Code § 47-1808.01(6). 2. Lower Capital Gain for Exchange of Investment in Qualified High Technology Company L. 2015, Act 20-514 (Law 20-210), effective 03/11/2015, enacts the “Promoting Economic Growth and Job Creation Through Technology Act of 2014.” This legislation establishes the tax rate for a capital gain from a sale or exchange of an investment in a Qualified High Technology Company (QHTC) meeting specified requirements. For tax years beginning after December 31, 2018, the tax rate on such capital gains will be 3% if: (1) the investment was made after the effective date of this Act; (2) the investment was held by the investor for at least 24 consecutive months; (3) at the time of the investment, the stock of the QHTC was not publicly traded; and (4) the investment is in common or preferred stock of the QHTC. To the extent this Act reduces revenues below the financial plan, it will apply as of January 1, 2019, or on the implementation of the provisions in D.C. Code Ann. § 47-181(c)(17) in effect on the effective date of this Act, whichever is later; provided that the priority list in D.C. Code Ann. § 47-181 is maintained. 3. Withholding Methods L. 2015, Act 20-522 (Law 20-176), effective 03/07/2015 (expires 10/18/2015), enacts the “Standard Deduction Withholding Clarification Temporary Act of 2014.” The temporary legislation provides that, regardless of which statutory method of determining withholding is used, no allowance for the standard deduction is permitted. 4. 15157249.1 IRS Adjustments and QHTC -5L. 2015, Act 20-555 (Law 20-179), effective 03/07/2015 (expires 10/18/2015), enacts the “Fiscal Year 2015 Budget Support Clarification Temporary Amendment Act of 2014.” The temporary legislation amends the “Fiscal Year 2015 Budget Support Act of 2014” (Act 20-424, Law 20-155) to provide that the defined tax credit related to IRS income adjustments will be applied over a 4-year period in equal amounts in tax years beginning on or after January 1, 2019. In addition, the temporary legislation provides that the following amendments in the Fiscal Year Budget Support Act of 2014 are applicable for tax years beginning after December 31, 2014: the amendments (1) clarifying the definition of “Qualified High Technology Company,” and (2) providing that “Qualified High Technology Company” does not include an online or brick and mortar retail store or a building or construction company. C. Credits 1. Equipment and Labor Costs Attributable to Alternative Fuel For tax years beginning on or after January 1, 2014 through tax years ending December 31, 2026, a credit equal to 50% of the equipment and labor costs directly attributable to the purchase and installation of alternative fuel storage and dispensing or charging equipment on a qualified alternative fuel vehicle refueling property. D.C. Code § 47-1807.10. For tax years beginning on or after January 1, 2014 through tax years ending December 31, 2026, a credit equal to 50% of the equipment and labor costs directly attributable to the cost to convert a motor vehicle licensed in the District from a vehicle that operates on diesel or petroleum derived from gas to a motor vehicle that operates on alternative fuel. D.C. Code § 471807.11. III. 15157249.1 Brief Biography/Resume of Providers A. CHRISTIAN M. MCBURNEY (B.A., magna cum laude, Brown University 1981; J.D. & Law Review, New York University School of Law 1985; LL.M Georgetown University Law Center, Taxation, 1992) is a partner with the Washington, DC Office of Nixon Peabody LLP. Former chair and vice-chair of the State and Local Tax Committee of the Taxation Section, District of Columbia Bar; coeditor-in-chief of the Journal of Multistate Taxation. A. KENNETH H. SILVERBERG (B.A. (Economics), University of Michigan, 1968; J.D., Georgetown University Law Center, 1973) is a partner with the Washington, DC Office of Nixon Peabody LLP. B. ROBERT G. TROTT (B.A, University of Virginia, 2000; MFA, Queens University, 2006; J.D., University of Michigan Law School. 2012) is an associate with the Washington, DC Office of Nixon Peabody LLP. DISTRICT OF COLUMBIA DEVELOPMENTS Donald M. Griswold, Esq. Walter Nagel, Esq. Jeremy Abrams, Esq. Crowell & Moring LLP 1001 Pennsylvania Ave., N.W. Washington, D.C. 20004 Phone: (202) 624-2500 Fax: (202) 628-5116 Email: [email protected] [email protected] [email protected] Web: http://www.crowell.com/statetax I. FISCAL YEAR 2016 PROPOSED BUDGET Mayor Muriel Bowser submitted her Fiscal Year 2016 Proposed Budget and Financial Plan to the District Council in a letter to Chairman Phil Mendelson on April 2, 2015. The $12.9 billion proposed budget entitled “Pathways to the Middle Class” solves the District’s $193 million budget gap and makes new investments in education, jobs, affordable housing, public safety, and infrastructure. The plan also includes several “policy initiatives” to increase general fund revenue to pay for the new investments and close the budget gap. The proposed initiatives include, among others, increasing the general sales tax rate from 5.75 percent to 6 percent and the sales tax rate for commercial parking from 18 percent to 22 percent; taxing E-cigarettes at the same rate as other tobacco; and increasing the statute of limitations on income tax audits. The plan estimates that these increases will generate $36 million in revenue in fiscal year 2016. Mayor Bowser’s proposed budget represents the 20th consecutive balanced budget in the District. Council members did not react favorably to the Mayor’s proposed sales tax increases at the first hearing on the budget on April 13, 2015. Chairman Mendelson criticized the budget for dipping into the District’s reserve funds, increasing taxes, and deferring maintenance of the District’s infrastructure. Council members Jack Evans and Mary Cheh also spoke out against the increases Recall that it was only a couple years ago that this Council reduced the sales tax rate, and members do not seem eager to move backwards. II. INCOME/FRANCHISE TAXES A. Legislative Developments i. Tax Relief Package On February 26, 2015, the D.C. Council enacted the Fiscal Year 2015 Budget Support Act of 2014. The tax relief bill incorporates several recommendations made by the D.C. Tax Revision Commission following its lengthy review of the D.C. tax system last year. The Emergency Act includes the following business franchise tax changes most of which are applicable for tax years beginning after December 31, 2014: Reduction over time of business franchise and unincorporated business franchise tax rate from 9.975 percent to 8.25 percent; Exemption of certain passive investment funds from business taxes; Error! Unknown document property name. Switch to single-sales factor apportionment; Application of market-based sourcing for sales other than sales of tangible personal property. The Act also makes changes to provisions applicable to Qualified High Technology Companies. It effectively overrules the BAE decision by limiting QHTC benefits to taxpayers “leasing or owning an office” in the District. The ACT also provides that “Qualified High Technology Company” does not include an online or brick and mortar retail store or a building or construction company. These QHTC changes are in addition to those enacted in prior years discussed below. ii. Market Sourcing Effective Date On March 26, 2015, the D.C. Council enacted the “Market-based Sourcing Inter Alia Clarification Congressional Review Emergency Amendment Act of 2015.” The emergency legislation keeps in effect an amendment that clarifies that the statute requiring market-based sourcing is applicable for tax years beginning after December 31, 2014. Prior legislation making the switch the market based sourcing failed to include an effective date causing much confusion and frustration among District taxpayers. The Office of Tax and Revenue has not yet issued market sourcing regulations. iii. Capital Gains Rate for Sales of QHTCs On March 11, 2015, the D.C. Council enacted the “Promoting Economic Growth and Job Creation Through Technology Act of 2014.” This legislation establishes the tax rate for a capital gain from a sale or exchange of an investment in certain QHTCs. For tax years beginning after December 31, 2018, the tax rate on such capital gains will be 3% if: (1) the investment was made after the effective date (March 11, 2015); (2) the investment was held by the investor for at least 24 consecutive months; (3) at the time of the investment, the stock of the QHTC was not publicly traded; and (4) the investment is in common or preferred stock of the QHTC. iv. Multistate Tax Compact (Prior Years) As part of the Fiscal Year 2014 Budget Support Emergency Act of 2013, the D.C. Council repealed the Multistate Tax Compact and reenacted a modified version of the Compact that does not include the Article III election provision or the Article IV apportionment formula. The change is effective for tax years beginning after December 31, 2012. Observations In 2011, D.C. departed from the Compact-apportionment method by switching from UDITPA’s three-factor property, payroll, & sales formula to a four-factor formula with double-weighted sales. By repealing and reenacting the Compact, DC joins a growing list of jurisdictions around the nation that have taken preemptive action to minimize exposure for large refunds based on the Compact election provision a la Gillette v. Franchise Tax Board. Taxpayers should compute their tax using the Compact method in 2011 and 2012 and consider whether filing refund claims may be appropriate. If the Compact-election issue is ever litigated in D.C., it will be interesting to see how the courts respond to the government/MTC argument that the Compact never received Congressional approval. D.C. legislation adopting the Compact was reviewed and approved by both houses of Congress in 1981. v. Mandatory Unitary Combined Reporting (Prior Years) Effective September 14, 2011, the District has adopted a combined reporting regime for corporations and unincorporated business entities for tax years beginning after December 31, 2010. Any taxpayer engaged in a unitary business with one or more other corporations that are part of a water’s-edge combined group must file a combined report which includes the income and the allocation and apportionment factors of all such corporations. “Unitary business” is defined as “a single economic enterprise that is made up either of separate parts of a single business entity or of a commonly controlled group of business entities that are sufficiently interdependent, integrated, and interrelated through their activities so as to provide synergy and -2Error! Unknown document property name. mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts.” Each member of the combined group is required to calculate its own tax liability. The law also permits taxpayers to make an election to file a worldwide combined report, in lieu of filing on a water’s-edge basis. On July 30, 2013, the Mayor signed the Fiscal Year 2014 Budget Support Emergency Act of 2013 (A20-130). The emergency legislation makes technical changes to the combined reporting statute including the following: modifying the definition of “corporation” to conform to the legislation to final regulations; clarifying that the term “person” does not include Qualified High Technology Companies, thus excluding QHTCs from inclusion in the combined group; removing references to partnerships and unincorporated businesses; authorizing the CFO to adopt regulations explaining the treatment of unincorporated businesses and distributive shares therefrom within the combined group to prevent double taxation; eliminating the requirement that the election of a designated agent be made annually; removing subpart F income from the calculation of tax on a water’s-edge unitary group; and eliminating the automatic renewal of the worldwide election at the end of the ten-year period. Observations In 2012, the District raised $45 million more revenue than expected largely as a result of combined reporting. However, almost 2 years into this experiment, taxpayers and practitioners alike still desire more clarity on the law. The Office of Tax and Revenue issued final regulations on September 14, 2012, and continues to put out new guidance to assist taxpayers. For example, OTR has created a worksheet and instructions explaining how to include distributive shares from partnerships and unincorporated businesses in a combined report. Both are available on OTR’s website. We are told that the statute and/or regulations will be amended again to reflect these explanations. Better late than never. vi. Qualified High Technology Companies (Prior Years) Effective March 5, 2013, D.C. Law 19-211, the Technology Sector Enhancement Act of 2012 (A19-513), makes the following changes to the taxation of QHTCs: The Act repeals a provision excluding from gross income qualified capital gain from the sale or exchange of a QHTC asset held for more than 5 years and amends the definition of a QHTC to clarify (1) that an entity must have two or more employees in the District; and (2) that the qualifying revenue test applies to revenues earned in the District. The Act also provides that (1) before January 1, 2012, a certified QHTC shall not be subject to franchise tax for 5 years after the date that the QHTC commences business in the District; and (2) on or after January 1, 2012, a certified QHTC shall not be subject to franchise tax for 5 years after the date the QHTC has taxable income. The Act limits the total amount that each QHTC may receive in exemptions to $15 million. In addition, the Act requires the Tax Revision Commission to analyze a proposal to tax the capital gain from the sale of QHTC stock at the rate of 3 percent. Observations One area where the District can compete with Virginia and Maryland in terms of business-friendly taxation is the treatment of QHTCs. A broad range of business activities may qualify a business for QHTC treatment. Taxpayers should consider whether they qualify as a QHTC or whether, with a little planning, they can qualify going forward. vii. Employer Withholding (Prior Years) Emergency legislation keeps in effect a requirement that an employer or a payor who is required to withhold income tax submit to the Chief Financial Officer (CFO) by January 31 of each year a statement of information for employee or person regarding the prior year payments. An employer or payor required to submit 25 or more statements shall do so electronically. The CFO may waive the electronic filing -3Error! Unknown document property name. requirement if the CFO determines that the requirement will result in undue hardship to the employer or payor. B. Judicial Developments i. Flow Through Apportionment Alenia N. America, Inc. v. D.C. Office of Tax and Revenue, No. 2012-OTR-00015 (D.C. O.A.H. Mar. 11, 2014) In Alenia, the Office of Administrative Hearings granted summary judgment to the taxpayer allowing it to include in its own apportionment calculation the apportionment factors from a pass through entity in which it owned a controlling interest. The taxpayer owned a 51 percent interest in a partnership that did not earn any income in the District. The taxpayer included its distributive share of partnership income in its income and the partnership’s apportionment factors in its own apportionment computation. OTR excluded the flow through factors from the taxpayer’s apportionment on audit. The parties agreed that the taxpayer’s distributive share of income from the partnership was business income from operation of a unitary business. After reviewing state court decisions on apportionment and considering the general purpose of the District’s apportionment statute, the OAH determined that the taxpayer may include the apportionment factors of a unitary pass through entity when calculating its own franchise tax apportionment because business income from a unitary business ought to be apportioned based on the apportionment factors of the business generating that income. The court rejected OTR’s argument that its regulation limited such treatment to taxpayers that file a consolidated return. ii. Statute of Limitations D.C. Office of Tax and Revenue v. Sunbelt Beverage, LLC, No. 10-AA-1331 (D.C. Ct. App. April 11, 2013) In Sunbelt, the D.C. Court of Appeals ruled that the District was barred by the 3-year statute of limitations from assessing franchise tax on an unincorporated business. Sunbelt, a limited liability company doing business in the District of Columbia, mistakenly filed Form D-65 (Partnership Return of Income) instead of Form D-30 (Unincorporated Business Franchise Tax Return). On its partnership return, Sunbelt accurately reported its gross income and deductions and identified its corporate parent, which filed Form D-20 (Corporation Franchise Tax Return). However, Sunbelt did not report an apportionment factor or District taxable income. The parties stipulated that Sunbelt had no intent to evade tax. OTR issued a notice of proposed assessment more than three years after Sunbelt filed its partnership return. Sunbelt protested the proposed assessment based on the expiration of the statute of limitations. OTR argued that Sunbelt’s return was a nullity because it omitted material information that would allow OTR to determine the correct amount of tax due. Therefore, according to OTR, the statute of limitations never began to run and OTR could assess a deficiency at any time. The Office of Administrative Hearings granted summary judgment in Sunbelt’s favor. On appeal, the court reviewed the structure and purpose of the statutory limitations period in light of Supreme Court case law on what constitutes a return. The court held that perfect accuracy is not required. Instead, to trigger the statute of limitations, the taxpayer must file a document that is intended as a return, identifies the taxpayer, and provides information about the taxpayer’s income. Moreover, the government has an obligation to examine the return in a timely manner to determine if more information is required. In this case, Sunbelt’s return triggered the statute of limitations because it was filed on a governmentsanctioned form, reported information about income, and included all necessary identifying information. The only information lacking was the apportionment formula which was not necessary for OTR to determine whether Sunbelt was liable for tax. As a result, Sunbelt’s return was not a nullity and OTR should have proposed an assessment within the statutory three-year period. iii. Qualification for High Technology Benefits -4Error! Unknown document property name. Office of Tax and Revenue v. BAE Systems Enterprise Systems Inc., No. 10-AA-1071 (D.C. Ct. App. Nov. 29, 2012) The taxpayer claimed that it qualified for a franchise tax exemption granted to certain technology companies that, among other things, “maintain an office . . . or base of operations in the District”. Despite having over 180 employees working full-time at government facilities in the District, OTR took the position that the taxpayer did not “maintain” an office or base of operations because the taxpayer did not exercise “predominant dominion, control, or autonomy” over the facilities. At the trial level, the Office of Administrative Hearings (OAH) determined that the taxpayer maintained a base of operations in the District because its employees “reported to work at daily locations” in the District, to “conduct [the taxpayer’s] business of providing services to federal government agencies” and was entitled to the exemption from franchise tax. In affirming OAH’s decision, the Court of Appeals rejected an argument by the Office of Tax and Revenue (OTR) that the word “maintain” requires the taxpayer to exercise “predominant dominion, control, or autonomy” over the office or base of operations. The Court found OTR’s position unreasonable in light of the statute’s language, structure, and history and refused to give substantial deference to OTR’s interpretation. For purposes of the franchise tax exemption, the Court held that a taxpayer having “a sufficient number of employees performing qualifying high-technology work at a fixed location in a high-technology zone for a sufficiently extended period of time” will be deemed to maintain an office or base of operations in the District. Observations The Court of Appeals’ decision in BAE may present a refund opportunity for taxpayers that did not claim the franchise tax exemption or that were denied the franchise tax exemption because they did not “maintain” an office in the District under OTR’s flawed interpretation. However, the District Council effectively overruled BAE going forward with recent legislation amending the statutory QHTC provisions involved in the case. Crowell & Moring represented the taxpayer in this case. iv. Contract Transfer Pricing Audits Microsoft Corp. v. District of Columbia Office of Tax and Revenue, No. 2010-OTR-00012 (Office of Administrative Hearings April 23, 2011) Microsoft filed a Motion for Summary Judgment challenging OTR’s Notice of Proposed Assessment of Tax Deficiency in the amount of approximately $2.75 million. OTR had contracted with ACS State and Local Solutions, Inc., who then sub-contracted with Chainbridge Software, Inc. (“Chainbridge”), to provide a transfer pricing analysis of Microsoft’s transactions. Chainbridge issued a report, which found that Microsoft underreported its income for the 2002 tax year in which Microsoft reported a loss, and OTR applied that finding to the 2006 tax year to which Microsoft carried the loss forward. The issue in the case was whether the transfer pricing analysis performed by Chainbridge, and relied upon by OTR, was arbitrary, capricious, and/or unreasonable. The ALJ determined that it was, and granted summary judgment in Microsoft’s favor. Pursuant to D.C. Code §47-1810.03, OTR has the authority to adjust a taxpayer’s gross income and deductions arising from related-party transactions if necessary to clearly reflect the taxpayer’s income. This authority is analogous to the authority granted to the IRS under IRC § 482. Accordingly, the ALJ looked for guidance to the federal regulations promulgated under § 482 in the absence of District-specific regulations. Chainbridge, who conducts transfer pricing analyses for taxing jurisdictions across the country, analyzed Microsoft’s transactions for its 2002 tax year. Chainbridge purportedly followed the federal regulations and used the comparable profits method for its analysis. However, Chainbridge did not isolate controlled transactions between Microsoft and its affiliated businesses. Instead Chainbridge included all of Microsoft’s -5Error! Unknown document property name. income from any source. Chainbridge also did not attempt to compare similar goods and transactions but determined that all of Microsoft’s activities were interrelated because they constituted a computer software business. Based on its analysis, Chainbridge determined that Microsoft’s profit-to-cost ratio was outside the interquartile range of its comparables, and that Microsoft had therefore underreported its income. OTR issued a notice based on Chainbridge’s findings and disallowed the NOL deduction claimed by Microsoft on its 2006 tax return. The ALJ determined that Chainbridge committed two fatal errors. First, Chainbridge failed to measure controlled transactions against uncontrolled transactions conducted at arm’s length as the federal regulations require. Based on Chainbridge’s determination that Microsoft’s transactions were too complex and its related-party transactions too numerous to separate, OTR argued that the gross income reported by Microsoft on its D20 tax return was “the most narrowly identifiable business activity for which data incorporating the controlled transactions is available.” The ALJ rejected this contention as unsupported by any factors, and found the analysis to be arbitrary, capricious, and unreasonable because it did not measure what the regulations require it to measure. Second, Chainbridge failed to measure the profit-to-cost ratios of similar types of transactions. Although the record reflected that Microsoft engages in various different types of business activities, Chainbridge made no effort to compare like kind transactions. The ALJ stated that “without any differentiation of the comparable profits for different product and server lines, an overall profit level indicator is meaningless.” Accordingly, the ALJ ruled that OTR could not reallocate income between Microsoft and its affiliates on the basis of Chainbridge’s analysis, and granted summary judgment reversing OTR’s proposed assessment of tax deficiency. On December 17, 2012, OTR voluntarily dismissed its appeal to the District of Columbia Court of Appeals in this case. Several other cases pending in District courts involve issues similar to the issues in Microsoft. The cases are Hess Corp. v. District of Columbia, Shell Oil Co. v. District of Columbia, Exxon Mobil Oil Corp. v. District of Columbia, Eli Lilly and Co. v. District of Columbia, AT&T Services Inc. v. District of Columbia, and Ahold USA Holdings Inc. v. District of Columbia. BP Products North America, Inc. v. District of Columbia, No. 2011 CVT 10619 (D.C. Sup. Ct. Mar. 28, 2014) On March 28, 2014, BP Products North America, Inc. agreed to settle a similar dispute with the District. BP paid an assessment in excess of $720,000 following an audit by Chainbridge and subsequently filed a claim for refund of the full amount plus interest. Under the stipulated decision, BP agreed to accept just over $140,000 plus interest in full settlement of its claim, and the District will retain the remaining $580,000 in full satisfaction of the assessment. Observations The Microsoft decision, now final, could strike a major blow to OTR, who has relied on Chainbridge and other contract auditors for numerous transfer-pricing audits, presumably because it lacks the resources to conduct transfer pricing audits on its own. It is unclear if OTR will continue to use faulty transfer-pricing methods in examinations for years that remain open. However, the enactment of mandatory unitary combined reporting for tax years beginning on or after January 1, 2011, may obviate the need for OTR to use contract audits in the future. II. TRANSACTIONAL TAXES A. Legislative Developments i. Broadened Base -6Error! Unknown document property name. In addition to franchise tax changes discussed above, the Fiscal Year 2015 Budget Support Act of 2014 also broadens the sales tax base to cover services including bottled water delivery, storage of household goods, carpet cleaning, health clubs, tanning studios, car washes, bowling alleys, and billiard parlors. Similar legislation in prior years was vetoed by then Mayor Vincent Gray and the DC Council subsequently voted to override the Mayor’s veto. ii. Reduced Sales Tax Rate (Prior Years) Effective October 1, 2013, the general sales and use tax rate is decreased from 6 percent to 5.75 percent. The reduced rate only applies to transactions subject to the general 6-percent tax; special rates for prepaid telephone cards, certain rentals or leases, parking, tobacco products, and transient accommodations are not affected. For additional guidance, see OTR Notice 2013-05 (Sept. 17, 2013). iii. Remote-Seller Nexus and Sales Tax Collections (Prior Years) The Internet Sales Tax, Homelessness Prevention, and WMATA Momentum Fund Establishment Emergency Act of 2013 keeps in effect the provisions for imposing a sales tax on internet sales. Under the law as written, a seller that is a “remote-vendor” must collect and remit to the District sales and use taxes on sales made via the internet to a purchaser in the District (“remote sales tax”). A “remote-vendor” is a seller, whether or not it has a physical presence or other nexus within the District, selling via the internet property or rendering a service to a purchaser in the District. Vendors with a specified level of cumulative gross receipts from internet sales to purchasers in the District are exempt from the requirement to collect remote sales taxes. Remote sales tax collection is required within 120 days of the effective date of the legislation. OTR officials have stated that this law will not take effect until Congress passes the Marketplace Fairness Act. Also, before the District can require collection, the law requires the District to pass certain laws regarding privacy and confidentiality, a small-vendor exemption, and other simplification measures. Observations The Internet Sales Tax, Homelessness Prevention, and WMATA Momentum Fund Establishment Emergency Act of 2013 shall apply as of the effective date of the Marketplace Fairness Act of 2013. In what may prove to be one of its most bi-partisan moments in recent years, the U.S. Senate on May 6 passed the Marketplace Fairness Act by a vote of 69-27. The federal legislation would require remote sellers with more than $1 million in total sales to collect sales taxes in states that adopt sales tax simplification measures but would not provide a needed income tax safe harbor. While Main Street sellers with an in-state physical presence have waited for over two decades (since Quill was decided) for Congress to act, remote businesses have waited over five decades since Congress last created a state income tax safe harbor (P.L. 86-272). However, this income tax safe harbor, created in 1959, only applies to the sale of tangible personal property. During these decades, not only have remote sellers grown to account for a large share of all sales, but revenue from sales of intangible property has also become a significant share of the gross domestic product. Much of corporate America has implied over the years that it would accept sales tax collection obligations on remote sellers if a state income tax safe harbor was created for the sale of intangible property as a quid pro quo. However, if the Marketplace Fairness Act is enacted in its current form, remote sellers and state revenue departments alike will be left with years of litigation while the contours of the states’ ability to subject the income of remote sellers to taxes works its way through the courts. iv. Restaurant Utility Tax (Prior Years) Effective August 1, 2013, sales of natural or artificial gas, oil, electricity, solid fuel, or steam, directly used in a restaurant are exempt from sales tax. The term "restaurant" means a retail establishment that is licensed by the District of Columbia, a separately metered or sub-metered facility, and in the principal business of -7Error! Unknown document property name. preparing and serving food to the public. The term "restaurant" shall include a pizzeria, delicatessen, ice cream parlor, cafeteria, take-out counter, and caterer, and banquet and food-processing areas in hotels. The term "restaurant" does not include beverage counters, including coffee shops and juice bars. v. Alcohol Sold for Off Premises Consumption (Prior Years) Emergency legislation keeps in effect the 10-percent sales tax rate on the gross receipts of the sales of or charges for spirituous or malt liquors, beers, and wine sold for consumption off the premises where sold. B. Judicial Developments i. E911 Tax False Claims Suit A whistleblower has sued several telecommunications companies in Superior Court under the District’s False Claims Act alleging that the companies have failed to collect and remit over $29 million in Emergency 911 taxes. The defendants have filed a motion to dismiss. The case is Phone Recovery Servs., LLC v. Verizon Washington, DC, Inc., 2014 CA 002277 B (pending D.C. Superior Court). Crowell & Moring represents two of the defendants in the case. ii. District and Online Travel Companies Reach Settlement on Hotel Taxes District of Columbia v. Expedia, Inc., et. al., Case No. 2011 CA 0002117B (D.C. Sup.Ct. Sept. 24, 2012) On September 24, 2012, the Superior Court held that online travel companies are liable for sales tax on the full value of gross receipts from retail sales of hotel rooms to customers using their travel websites, thus handing the District an important victory in its efforts to increase revenues from sales tax collection. The District and the online companies have settled on the amount of damages stemming from the ruling. Under the agreement announced by Attorney General Irvin Nathan on February 24, 2014, Expedia, Hotels.com, Hotwire, Orbitz, Travelocity, and Priceline.com will pay a total of $60.9 million to the District, assuming the Court of Appeals affirms the Superior Court’s judgment. The companies can appeal by posting a bond or paying the stipulated judgment and seeking a refund. The District’s suit against Expedia, Hotwire, Orbitz, Priceline, Travelocity and several other online travel companies, alleged that they owed the District millions of dollars of annual sales tax revenue because the companies sell hotel rooms at retail prices, while paying District sales taxes based on the hotels’ discounted wholesale prices. The District asked the court, among other things, to declare that each Defendant is required by District law to collect and remit sales taxes based on the retail prices that the Defendants charge website customers for hotel rooms in the District of Columbia. Defendant online travel companies filed a Motion to Dismiss the case claiming they were not liable for hotel sales taxes because the online travel companies are not hotels and do not “furnish” rooms to customers. On October 12, 2011, the court denied the Defendants’ motion, and ruled that the business model of the Defendants was within the statutory definition of retail sales and that the transactions were therefore taxable. The court also found that the statute at issue did not require the seller of the room to actually furnish the room; it only required that the customer acquire the right to occupy the room in the transaction. While acknowledging the distinction between online travel companies and the hotels themselves, the court in its September 24, 2012 opinion held that the online travel companies fit within the statutory definition of “room remarketer” and that room remarketers are taxed on the full value of the transaction, including net charges and additional charges received by room remarketers, thereby removing any ambiguity regarding the online travel companies’ liability. -8Error! Unknown document property name. On December 11, 2012, the court denied the Defendant’s Motion to Amend Order to Permit Immediate Appeal and Motion for a Stay Pending Appeal. The court determined that there is not a substantial ground for a difference of opinion in interpreting the relevant sales tax laws, and that an immediate appeal would not materially advance the ultimate termination of the litigation. Accordingly, the statutory grounds for allowing an immediate appeal have not been satisfied. iii. Delinquent Sales Tax Plea Agreement Stedman v. District of Columbia, No. 08-CT-586 (D.C. 2011) The taxpayer operated a small carry-out restaurant during the years at issue, but failed to file sales tax returns. The taxpayer entered into a plea agreement with the District by which she plead guilty to four counts of non-willful failure to file monthly sales tax returns. In exchange, the District dismissed parallel counts charging willful non-filing, and suspended a three-month prison sentence. Under the agreement, the taxpayer was to “pay all District of Columbia taxes due,” consisting of “restitution, fees, penalties, and interest.” The District proposed a total restitution amount that included a 75% penalty for fraud. The Taxpayer challenged the penalty and asked for a judicial determination of whether her failures to file returns were willful, as the penalty statute requires. The District argued the agreement did not permit the taxpayer to contest the proof of willfulness. The District of Columbia Court of Appeals held that the taxpayer must be given the opportunity to challenge the government’s proof that her non-filings were “willful” and thus subject to the penalties imposed. The Court stated it was less reasonable to suppose that the taxpayer waived the right to dispute willfulness, and so the applicability of a hefty 75% penalty, without explicit language in the agreement that she meant to do so. C. Administrative Developments i. Sales Tax on Services The Office of Tax and Revenue has proposed regulations regarding collection of tax on services including bottled water delivery, storage of household goods, carpet cleaning, health clubs, tanning studios, car washes, bowling alleys, and billiard parlors pursuant to newly enacted legislation. III. PROPERTY TAXES A. Legislative Developments i. Tax Lien Sales (Prior Years) On September 17, 2013, the D.C. Council approved legislation declaring the existence of an emergency with respect to the need to require the CFO to review all residential real property tax liens sold between certain dates, to consider whether a real property tax lien, sale and foreclosure were the result of excusable neglect or other equitable circumstances warranting relief, and to identify the amount of funds needed to compensate persons for whom an equitable remedy would provide substantial justice. ii. Cogeneration Equipment (Prior Years) The Cogeneration Equipment Personal Property Tax Exemption Emergency Act of 2012 declares that beginning October 1, 2016, cogeneration equipment serving developments of more than 1 million square feet will be exempt when fuel used to generate electricity is already subject to tax in the District. iii. Clean Energy (Prior Years) The Energy Innovation and Savings Amendment Act of 2012 exempts from personal property tax certain solar energy systems, and beginning October 1, 2016, cogeneration systems. -9Error! Unknown document property name. iv. Electric Vehicle Charging Stations (Prior Years) The Energy Innovation and Savings Amendment Act of 2012 also clarifies that a “public utility” does not include a person or entity that owns or operates electric vehicle supply equipment but does not sell or distribute electricity, an electric vehicle charging station service company, or an electric vehicle charging station service provider. v. Eligibility for Exemption from Recordation Tax (Prior Years) Beginning October 1, 2013, a copy of the Mayor’s certification of exemption from real property transfer tax must be submitted at the time the deed is recorded. B. Judicial Developments i. Tax Board Acted Ultra Vires District of Columbia v. 17M Assocs., LLC, 98 A.3d 954 (D.C. 2014) The District of Columbia Court of Appeals reversed and remanded a judgment of the Superior Court, holding that the Board of Real Property Assessments and Appeals (“BRPAA”) acted beyond its power in determining that a lease agreement with the District exempted a company from a possessory interest tax. Although BRPAA members are qualified to decide disputes over a property's assessed value or classification, they are not qualified to decide whether a tax applied. ii. Real Property Tax Sale Threshold Aeon Financial LLC v. Fenty, No. 09 CZ 1379 (D.C. 2009) The District of Columbia Office of Tax and Revenue (OTR) promulgated an emergency regulation (9 DCMR 317.1) that established a $1,200 threshold for the sale of delinquent real property taxes at the District’s 2009 real property tax sale. The regulation provided that only those real properties owing $1,200 or more in taxes would be auctioned at the 2009 tax sale. The plaintiff filed suit challenging the regulation and the D.C. Superior Court issued a Preliminary Injunction that required OTR to include in the 2009 tax sale those parcels for which there were arrearages said to be under $1,200. The Court later issued an order vacating its Preliminary Injunction and establishing a schedule for the resolution of the case on the merits. The District filed a Motion to Dismiss and Motion for Summary Judgment. The D.C. Superior Court granted the motion in part ruling that the District had the authority to establish reasonable threshold limits on properties not to be placed in the Public Notice for sale. See Aeon Financial LLC v. Fenty, No. 2009 CA 006323 B (D.C. Super. Ct.). However, the Court denied the District’s motion with respect to the emergency regulation, holding that the regulation was invalid because it was promulgated in the absence of a justified emergency. See Id. In November 2009, the plaintiff filed an appeal with the D.C. Court of Appeals challenging the Superior Court ruling. However, that appeal was dismissed on April 27, 2010. - 10 Error! Unknown document property name. iii. Real Property Tax Sale Limitations Period Tangoren v. Stephenson and the District of Columbia, No. 07-CV-137, August 6, 2009 (D.C. Cir.) The District of Columbia Court of Appeals held that efforts by a successful purchaser to foreclose on property purchased at a District of Columbia real property tax sale two and a half years earlier were not time-barred because the usual statutory one-year period of limitations did not apply due to the District’s failure to provide an issue date on the applicable certificate of sale given to the purchaser. iv. Real Property Tax Sale Notice to Defunct Corporation CCD-SAT, Inc. v. Pratt, 972 A.2d 322 (D.C. Cir. 2009) The District of Columbia Court of Appeals held that the District was not excused from providing the statutorily required 30-day notice regarding the impending tax sale of a Maryland corporation’s real property in the District (and of the right to redeem that property) even though, at the time the notice to the corporation was due, the corporation was in default under Maryland law and its corporate status had been forfeited. Instead, such notice was still required because the corporation’s sole director and registered agent stood in the shoes of the defunct corporation, and should have received notice. As a result, the court held that the tax sale and the subsequently issued tax deed must be set aside because of the District’s failure to strictly comply with the statutory notice requirement. C. Administrative Developments i. Recordation Tax Treatment of Refinanced Commercial Properties Opinion of the Attorney General (Jul 25, 2011) There is a dispute between the Office of Tax & Revenue (OTR) and the D.C. Council about the proper assessment of the recordation tax with respect to refinanced loans. Specifically, the debate is over whether the recordation tax must be paid on the full amount of the new loan (the Council’s position) or the difference between the amount of the new loan and the old one (OTR’s position). The District’s Attorney General has opined that OTR was not erroneous in concluding that, on a refinancing of commercial property, recordation tax is due only on the amount of debt in excess of the original indebtedness. In 2001, the District enacted the Tax Clarity Act of 2000 (the “Act”). Prior to the Act, the refinance of a purchase money security interest instrument was exempt from recordation tax up to the amount of the existing debt. The Act amended this provision and arguably requires the payment of recordation tax on the entire amount of the new debt (to the extent that tax was not already paid). However, the Act’s legislative history is void of any claims that the original exemption for refinanced debt was intended to be removed. Further, the CFO’s fiscal impact statement indicated that there would be no revenue impact from the amendments and that the statutory amendment simply clarified “current practice.” The Attorney General found that a plain reading of the Act suggests that the recordation tax should be assessed on the full amount of the indebtedness, to the extent that no recordation tax was paid on the original indebtedness. However, the legislative history points in the opposite direction, indicating that the Council did not intended to change prior practice under which the tax was imposed only on the additional amounts of indebtedness, continuing the exemption for the original debt amount. The Attorney General has recommended that the Act be amended to make clear that on any refinancing the recordation tax be imposed on the full amount of the indebtedness, to the extent that no tax was paid on the recording of the original debt. - 11 Error! Unknown document property name. IV. MISCELLANEOUS / OTHER ITEMS OF INTEREST A. Judicial Developments i. OAH Lacks Authority to Sanction OTR for Behaving Badly D.C. Office of Tax and Revenue v. Shuman, et al., No. 12-AA-466 (D.C. 2013) The D.C. Court of Appeals ruled that the Office of Administrative Hearings has no authority to enjoin or sanction the Office of Tax and Revenue no matter how badly OTR’s actions may be. This case stems from OTR’s repeated and erroneous notices to the taxpayers for an individual income tax liability they did not owe, due to an error in OTR’s computer systems. Despite acknowledging the error and agreeing not to issue further notices, OTR, its computer system, and its bill collectors continued to send notices to the taxpayers over several years, causing bigger tax problems, personal distress, and prolonged proceedings at the OAH. In response, the OAH enjoined OTR from sending further notices to the taxpayers and ordered OTR to fix its computer system, subjected OTR to pay daily fines if it failed to correct the problems, and sanctioned OTR for wasting the OAH’s resources, ordering it to pay over $80,000 to the OAH. After ruling that the OAH had jurisdiction over the taxes at issue, the Court of Appeals ruled that the OAH, an administrative agency, had no statutory authority to enjoin or sanction OTR, actions reserved for judicial bodies. Accordingly, the Court overruled the OAH’s order issuing injunctive relief and sanctions, noting that the taxpayers could seek equitable relief in Superior Court. ii. Dismissal Without Prejudice of Pending Litigation in Light of Settlement Agreement District of Columbia v. Young, No. 11-CV-265 (D.C. March 8, 2012) The District sued the taxpayer in D.C. Superior Court to recover unpaid unincorporated business franchise taxes and sales and use taxes. While the lawsuit was pending, the District and the taxpayer entered into a settlement agreement requiring the taxpayer to pay a settlement amount that was substantially lower than the District’s original claim over a set number of installment payments. The settlement agreement included a provision that allowed the District to “pursue enforcement of [the] Agreement and/or collection of the taxes owed, by any means permitted under law”, should the taxpayer default on the agreement. The settlement agreement did not address explicitly the disposition of the District’s pending lawsuit against the taxpayer. After the agreement was executed the District proposed to dismiss its pending lawsuit without prejudice, so that it could reinstate the lawsuit in the event the taxpayer defaulted on his payment obligations. The taxpayer argued that the District had foregone that remedy by entering into the settlement, and maintained that the case had to be dismissed with prejudice. The D.C. Superior Court agreed with the taxpayer on the basis that because the District had agreed to accept the reduced settlement amount in “full and final settlement,” and the taxpayer had begun making the required payments, the District was barred from any attempts to reserve the right to relitigate the issues and seek the original debt amount. On appeal, the D.C. Court of Appeals reversed the decision of the lower court. The Court of Appeals reasoned that because the taxpayer had not fully satisfied his obligations under the settlement agreement, by the express terms of the agreement the District was allowed to enforce its original claim against the taxpayer for the full amount of the tax liability in the event he defaulted on his payment obligations. iii. Work-Product Protection United States v. Deloitte LLP et al., No. 09-5171 (D.C. Cir., June 2010) The U.S. Court of Appeals for the District of Columbia Circuit held that a corporation did not waive workproduct protection by disclosing two documents (the first document prepared by the corporation’s accountant - 12 Error! Unknown document property name. and in-house attorney, and the second document prepared by the corporation’s outside counsel) to its independent auditor; however, a third document, created by the auditor, was ordered to be produced for in camera review to determine any privilege. Although this is a federal tax case, it may have important implications in state tax audits and controversies. Over the years, state tax authorities have increased their efforts to obtain documents that are arguably covered by the attorney-client or work-produce privileges. The Deloitte case may thwart efforts by state governments to obtain such information from taxpayers and their advisors. B. Government / Administrative Developments i. Offer In Compromise The Office of Tax and Revenue released an updated Form OTR-10 Booklet, Offer in Compromise, on August 13, 2014. The booklet explains important information about OTR’s Offer in Compromise Program including eligibility, instructions for requesting an OIC, and payment information. The booklet can be found on OTR’s website. ii. Fiscal Year 2014 Annual Financial Report Mayor Muriel Bowser and DC Chief Financial Officer Jeffrey S. DeWitt recently released the District’s 2014 Comprehensive Annual Financial Report (CAFR). Here are the key findings in the CAFR: VI. Total General Fund Balance now $1.87 billion, up from $1.75 billion; Legally mandated local and Federal reserves will increase by $72 million to $863 million providing 45 days of operating funds; Credit ratings were enhanced to AA by Fitch and Standard & Poor’s during FY 2014; The major factor contributing to the improved financial condition was maintaining expenses below the budget; and The strong end to FY 2014 demonstrates the District’s financial discipline to address future budget challenges. PROVIDERS’ BRIEF BIOGRAPHY/RESUME A. Donald M. Griswold Don is a partner in Crowell’s State Tax Group, resident in the Washington, D.C. office. He serves as a trusted counselor to corporate tax executives regarding the multistate tax issues that matter most to them. Over his nearly 30 year career in state tax, Don’s record of success litigating and settling tough tax controversies includes obtaining tens of millions of dollars in state tax refunds based on novel legal and constitutional issues, and achieving even larger reductions of tax assessments. He represents Fortune 500 companies around the country before administrative agencies, state and federal courts, and legislative bodies – but achieves most of his greatest successes for clients in confidential negotiated settlements far away from the media spotlight. His advice is particularly valued by clients seeking to reevaluate and improve the quality and viability of their forward-looking state tax planning. Prior to joining Crowell, Don was KPMG’s national partner-in-charge of State Tax Technical Services, an inhouse tax attorney with a large financial institution, and a partner in another law firm’s nationally-known state tax practice. Respected for his thought leadership in the field of state and local tax, Don is frequently invited to speak on a wide variety of state tax topics at conferences around the country. He serves on the advisory boards of several state tax organizations, including BNA Multistate Tax Advisory Board, Hartman - 13 Error! Unknown document property name. State Tax Forum, and the Maryland Comptroller’s Business Advisory Council. A recognized authority on tax-related constitutional issues, Don is an Adjunct Professor at Georgetown University Law Center. B. Walter Nagel Walt is a partner in Crowell’s State Tax Group, resident in the Washington, D.C. office. He focuses his practice on tax planning, tax policy and controversies for Fortune 500 clients. Walt has strong experience in the corporate sector. He previously served as Vice President & General Tax Counsel for MCI and as the President of Peracon, an electronic commerce company. Walt is an Adjunct Professor of Law at the Georgetown University Law Center. He is a nationally recognized expert in the taxation of major corporations with particular expertise in telecommunications taxation, having spent over a decade working on technology, telecommunications and electronic commerce matters, including as counsel to one of the commissioners of the U.S. Advisory Commission on Electronic Commerce and as an advisor to the Multistate Tax Commission. Walt has appeared in the Washington Post, The Wall Street Journal, and the FOX Business Channel, and he is the editor of two legal treatises. Walter has been invited to speak before the Congressional Internet Caucus, the IRS, the National Conference of State Tax Judges, the Congressional Chief of Staff Retreat, the Federation of Tax Administrators, the Multistate Tax Commission and numerous taxpayer associations, bar associations, and law schools. C. Jeremy Abrams Jeremy is a counsel in Crowell’s Washington, D.C. office where he represents corporations and partnerships in complex tax matters. He focuses his practice on state tax litigation and consulting. Jeremy defends against tax assessments and prosecutes refund claims before administrative agencies and in state courts around the country. He also advises clients on state tax planning, business aviation matters, financial statement reporting, multistate voluntary disclosures, and state tax due diligence. Jeremy frequently speaks on state tax issues at events hosted by Tax Executives Institute (TEI). He served for two years as attorney-adviser to Judge Juan F. Vasquez of the United States Tax Court before joining Crowell & Moring’s state tax team. Prior to that he was a senior associate in KPMG’s SALT practice. Jeremy is also an associate member of the nation's only tax law Inn of Court. - 14 Error! Unknown document property name. MAINE STATE TAX DEVELOPMENTS SPRING 2015 Sarah H. Beard, Esq. PIERCE ATWOOD LLP Merrill’s Wharf 254 Commercial Street Portland, ME 04101 [email protected] (207) 791-1378 I. INCOME TAX/FRANCHISE TAX A. Legislative Developments Maine Conforms to Internal Revenue Code. Maine enacted P.L. 2015, ch. 1 (February 12, 2015), conforming Maine's income tax law to the federal Internal Revenue Code through December 31, 2014 with certain exceptions. See The law includes conformity to the extender items enacted by the federal government in December, except that Maine continues to decouple from federal bonus depreciation. The law extends through 2014 the Maine capital investment credit for property placed in service in Maine (a credit that mimics bonus depreciation for certain property). Maine tax forms and instructions for 2014 anticipated this legislation, so no changes to these tax forms or instructions were made following enactment of Public Law, Chapter 1. B. Judicial Developments None to report. (See Maine Board of Tax Appeals decisions, described below). C. Administrative Developments Maine Board of Tax Appeals, Scope of P.L. 86-272 Protection. In a redacted 2-1 decision, issued in April, 2014 (published several months later), the Maine Board of Tax Appeals found that activities conducted by an independent sales broker on behalf of an out of state company in Maine exceeded the protection of P.L. 86-272. The third board member found the activity protected by P.L. 86-272. Unprotected activity, according to the majority, consisted of: “[the Broker’s] gathering of information on the types and quantities of products displayed and the manner of exhibition—including whether or not competitors’ products are displayed”; “observation and reporting of [defects in] a product’s condition” which was of “obvious qualitycontrol value to the Taxpayers”; and “actual manipulation of products displayed on the retailers’ shelves, such as [correcting significant visible defects in Taxpayers’] products or affixing coupons and tags to products to make them more attractive.” The Board found, however, that penalties must be waived: “the line between the activities engaged in by the Taxpayers and those {W4803995.1} protected under P.L. 86-272 is not so clear that the Taxpayers did not have substantial authority for their filing position, even though that position was erroneous.” The decision, which was not appealed, is not precedential. BTA-2013-6, April 2, 2014. The Board has heard at least one other case on the scope of P.L. 86-272 since issuing that decision, but no other decisions have yet been published. Maine Board of Tax Appeals, Federal Tax Benefit Rule Inapplicable. The Maine Board of Tax Appeals was asked to determine whether the federal “tax benefit rule” could be invoked to reduce the Taxpayers’ 2011Maine individual income tax liability. Taxpayers were Maine nonresidents with Maine source income derived from a business conducted in Maine. They sold the business in 2011 and recognized long-term capital gains. A Maine statutory provision required add back of federal net operating loss (NOL) carried forward to 2009 through 2011 tax years. (The add back was balanced by a corresponding subtraction in future years, but because the business was sold in 2011 presumably Taxpayers could not use the NOL carry forward in future periods.) Taxpayers sought to use the federal tax benefit rule as authority to use the NOLs to offset their Maine source income in 2011. The Board held that Maine’s NOL add back statute left no room for the tax benefit rule, and that Taxpayers could not use NOL carry forwards that did not appear on their federal return for that year under Green v. State Tax Assessor, 562 A. 2d 1217 (Me. 1989). BTA-2013-8, September 12, 2013. Maine Board of Tax Appeals, Taxpayers Subject to Double Taxation on IRA Distributions. The Board of Tax Appeals determined that Taxpayers, who had moved from another state to Maine, were not entitled under the Equal Protection, Full Faith and Credit, Commerce or Due Process Clauses to subtract IRA distributions that were correctly included as part of their federal adjusted gross income for 2011 and 2012 in computing their Maine income tax for those years, in spite of the fact that the amounts were received in 2010 and were subject to tax in 2010 by their former state of residence, which had decoupled from the federal treatment. BTA-2014-2, August 8, 2014. MRS Proposes Amendment to Rule 801, “Apportionment.” Maine Revenue Services (MRS) proposes to restructure section .06 “Sales factor” of the apportionment rule, and to recognize an exclusion from the numerator of the sales factor for years beginning on or after January 1, 2013, for the sales of a person whose only business activity in Maine is the performance of services directly related to a declared state disaster or emergency. Another change clarifies that “gross receipts” means an amount net of returns and allowances. MRS Proposes Amendments to Rule 803, “Withholding Tax Reports and Payments.” MRS has proposed numerous clarifying changes to Rule 803, which identifies income subject to Maine withholding, prescribes the methods for determining the amount of tax to be withheld and explains related reporting requirements. One proposed amendment reflects an important change in filing requirements: there will be separate filing, payment and processing of Maine income tax withholding and unemployment contributions for tax periods beginning after 2014 and billing notices issued after June 18, 2014. Another proposed amendment reflects the recent statutory change that allows the State Tax Assessor to establish the due date for providing Maine withholding information statements to payees; generally, under the provisions of the proposed rule, each statement is due the same date that the related federal statement is due. {W4803995.1} Amendments to Rule 805, “Composite Filing.” MRS has proposed amendments to Rule 805, which provides information regarding the filing of composite returns of income by partnerships, estates, trusts, and S corporations on behalf of nonresident partners, beneficiaries, or shareholders. MRS proposes to update a reference to the statute as a result of a recent law change and to make miscellaneous technical changes. II. SALES AND USE TAX None to report. III. PROPERTY TAX A. Legislative Developments None to report. B. Judicial Developments None to report. C. Administrative Developments On March 24, 2015, Maine Revenue adopted amendments to Rule 208 “Revaluation Guidelines,” which explains the process of revaluation of property and offers guidance for professionals providing revaluation services. Aside from technical changes, the only change of significance is to eliminate the requirement for a municipality to obtain approval from the State Tax Assessor prior to using a new pricing schedule. Instead, municipalities are now required to provide a copy of new pricing schedules to the State Tax Assessor only upon request. IV. OTHER - Governor’s Tax Reform Proposal Maine Governor Paul LePage has proposed a major restructuring of Maine’s tax system as part of his FY 2016-2017 budget submission. After a series of public hearings in February 2015, the proposal is now being scrutinized by the Legislature’s Appropriations and Taxation Committees. The Governor has also been taking his proposal on the road, presenting information sessions to generate public support. Generally, the governor’s proposal would decrease the state’s reliance on income tax revenue and increase its reliance on consumption-based sales and use tax revenue. The sales tax increase would come in the form of both increased rates and taxation of new services provided to consumers. The proposal would also likely result in increased property taxes, and would allow municipalities to tax larger nonprofit entities for the first time. Maine estate taxes would be phased out. Proposed changes include: {W4803995.1} Income tax Beginning with the 2016 tax year, the top individual income tax rate would be lowered gradually from the current 7.95 percent to 5.75 percent for 2019. The ability to claim itemized deductions (e.g., charitable contributions, mortgage interest) would be eliminated for the 2016 tax year and beyond. For 2015, deductions would be limited to $27,500 (other than medical expenses). Various tax credits would be eliminated, including the high-tech credit, the jobs and investment credit, the biofuel production credit, and various credits for employerprovided services (e.g., day care). Beginning with the 2017 tax year, the top corporate income tax rate would be lowered gradually from the current 8.93 percent to 7.5 percent for 2021. Estate Tax The estate tax exemption would be increased from $2 million to $5.5 million for individuals dying in 2016. The estate tax would be eliminated for decedents dying in 2017 or after. Sales and Use Tax / Service Provider Tax Tax rates on various items would change. The general sales and use tax rate would increase to 6.5 percent; lodging taxes would remain at 8 percent; the tax on prepared foods would drop to 6.5 percent; the service provider tax would be at 6 percent; and the tax on short-term auto rentals would decrease to 8 percent. The tax base would be increased dramatically, applying to: o Domestic and household services (e.g., landscaping, cleaning) o Installation, repair, and maintenance services (all property other than motor vehicles and aircraft) o Personal services (e.g., hair care, event planning) o Personal property services (e.g., dry cleaning, pet services) o Professional services (e.g., legal, accounting, architectural) o Additional prepared foods (e.g., candy, soft drinks, snacks) o Recreation and amusement services (e.g., movies, golf, skiing) The service provider tax would be expanded to apply to cable, satellite, and radio services, and personal interstate and international telecommunications services. An important exemption would be created for sales to businesses of professional services, personal property services, and installation, repair, and maintenance services. Property Tax Business equipment eligible for the Business Equipment Tax Reimbursement program (BETR) would be transitioned to the Business Equipment Tax Exemption program (BETE) over a four-year period, with BETR fully eliminated in 2019. There is no exception for property enrolled in a Tax Increment Financing agreement (TIF), as had been the case with the most recent BETR conversion proposal. BETR would be funded at 90 percent until its elimination. (It had been scheduled to return to 100% funding.) {W4803995.1} Municipal revenue sharing would be funded for the fiscal year beginning July 1, 2015, but would be eliminated the following year. This lack of revenue shared with municipalities would have to be offset by increased local property taxes, reduced spending, or a combination of both. Higher property taxes would have a major negative impact on capital intensive businesses. The exemption for nonprofit entities, other than churches, would be limited to the first $500,000 of value and 50 percent of the excess above $500,000. The telecommunications tax (paid to the state) would be repealed, and municipalities would be given authority to collect local property tax on that property. New retail property would cease to be eligible for BETE or BETR. Existing retail property would be eligible for BETE only through 2025. The tree growth and open space property tax programs would require additional compliance measures at both the individual and municipality levels. VI. PROVIDER’S BIOGRAPHY Sarah Beard is a partner and member of Pierce Atwood LLP’s State & Local Tax Group. Her practice includes state and local tax counseling and transactional planning, as well as litigation at the administrative level and in court. She is admitted to practice in Maine and Massachusetts. Sarah has been listed in editions of The Best Lawyers in America for Tax Law every year since 2007. She is a past Chair of the Taxation Section of the Maine State Bar Association, and is a member of the Taxation Section of the American Bar Association. Sarah is an Executive Committee member and past Chair of the National Association of State Bar Tax Sections. She is a member of the Advisory Board for the New England State and Local Tax Forum. {W4803995.1} MARYLAND STATE DEVELOPMENTS Alexandra E. Sampson, Esq. Reed Smith LLP 1301 K Street, NW, Suite 1000 – East Tower Washington, D.C. 20005 Phone: 202-414-9486 Fax: 202-414-9299 Email: [email protected] For additional information and articles, see www.reedsmith.com/mdtax. I. INCOME/FRANCHISE TAXES A. Legislative Developments i. 2014 New and Extended Income Tax Credits & Incentives The Maryland General Assembly passed legislation that creates or extends a number of credits against Maryland corporate income tax liabilities, including the following: Research and Development. Amendment to the research and development tax credit to increase the credit from $8 million to $9 million the aggregate amount of credits that the Department of Business and Economic Development (DBED) may approve in each calendar year. See SB 570; effective June 1, 2014 (applicable to all Maryland R&D credits certified after December 15, 2013. Regional Institution Strategic Enterprise (RISE) Zone Program. New incentives for business entities that locate in a RISE zone. Such an entity is entitled to depreciate 100% of qualified property within a RISE zone in the year in which the property is placed in service. The business entity may also claim enterprise zone income tax credits for regular and economically disadvantaged employees. The credit is $1,000 per regular employee (or $1,500 per regular employee in a focus area) and $6,000 per economically disadvantaged employee (or $9,000 per economically disadvantaged employee in a focus area). The entity is also entitled to a property tax credit and priority consideration for assistance from the state’s economic development and financial assistance programs. See SB 600 / HB 742; effective June 1, 2014. Sustainable Communities Tax Credit. Extension of the Sustainable Communities Tax Credit Program through fiscal year 2017. See HB 510; effective June 1, 2014. US_ACTIVE-109273875.8-AESAMPSO 04/13/2015 3:23 PM Health Enterprise Zone Program. Expands the credit to include “health enterprise zone employers” (which includes a health enterprise zone practitioner, a for-profit entity, or a nonprofit entity that employs qualified employees and provides health care services in an health enterprise zone. Prior to this change, the credit only included “health enterprise zone practitioners”. The legislation also extends the credit through tax year 2016 (formerly, applicable through tax year 2015 only). See HB 668; effective June 1, 2014. Electric Vehicles and Recharging Equipment. Repeals the Electric Vehicle Recharging Equipment income tax credit and replaces the credit with a rebate program. An annual maximum of $600,00 in rebates may be awarded in fiscal 2015 through 2017. Also, the Qualified Electric Vehicle Excise Tax Credit is amended to 1) alter the calculation of the credit, 2) specify that the credit is only available to qualified vehicles that are purchased new and titled for the first time before July 1, 2017, and 3) extend the program through fiscal year 2017. See SB 908 / HB 1345; effective July 1, 2014. ii. 2013 New and Extended Income Tax Credits During the 2013 legislative session, the Maryland General Assembly enacted legislation that created or extended a number of credits against Maryland corporate income tax liabilities. They included: Tractor Registration. New credit for the expense of registering a class F tractor vehicle (applicable to taxable years beginning after December 31, 2013, but before January 1, 2017). See HB 102; effective September 1, 2013. Cybersecurity Investment. New refundable credit for qualified investments in Maryland cybersecurity companies (applicable to taxable years beginning after December 31, 2013, but before January 1, 2019, and will terminate June 30, 2019). See HB 803; effective July 1, 2013. Wineries and Vineyards. New credit for qualified capital expenses made in connection with the establishment of new wineries or vineyards or capital improvements made to existing wineries or vineyards (applicable for tax years beginning after December 31, 2012, and expires June 30, 2018). See HB 1017; effective July 1, 2013. Employer Security Clearance Cost. Amendment to the employer security clearance cost tax credit to increase the maximum amount of the credit from $100,000 to -2- $200,000, and from $250,000 to $500,000 for multiple sensitive compartmented information facilities. See SB 482; effective July 1, 2013. iii. Historic Preservation Credit. Amendment to the credit for the restoration and preservation of a structure that has historic or architectural value to increase the credit from 10% to 25% of properly documented expenses (applicable to tax years beginning after June 30, 2013). See SB 144/HB 263; effective June 1, 2013. Amendment to Biotechnology Investment Credit The biotechnology investment tax credit permits an investor who invests at least $25,000 in a qualified Maryland biotechnology company to claim a credit equal to 50% of the investment, not to exceed $250,000. When the credit was first established, a “qualified Maryland biotechnology company” was required to, among other things, have been in business for less than 10 years. Over the years, the Maryland Legislature has approved a number of exceptions to the 10-year limitation. The current amendment adds an additional exception by generally allowing a company to qualify for tax credits for up to 10 years from the date the company first received a qualified investment from an investor eligible for the tax credit. The amendment applies to all initial tax credit certificates issued after June 30, 2013. See HB 328/SB 779. iv. Amendment to Film Production Credit The Maryland General Assembly has extended the termination date of the film production activity tax credit from July 1, 2014 to July 1, 2016. The General Assembly also increased the total amount of film production activity tax credits the DBED may award to film production entities from $7.5 million to $25 million for fiscal year 2014 only. See SB 183. Despite industry pressure to further increase the amount of film production activity tax credits that may be awarded, a measure that would have increased the total amount of credits that could be awarded in fiscal year 2015 from $7.5 million to 18.5 million failed. See SB 1051. However, the Budget Reconciliation and Financial Act of 2014 authorizes the use of $2.5 million from the Special Fund for Preservation of Cultural Arts in Maryland and $5 million from the Economic Development Opportunities Program Account to supplement the tax credits awarded under the film production activity tax credit program. See SB 172. v. Qualifying Employees with Disabilities Tax Credit Extended Maryland allows an employer who hires a qualified individual with disabilities to claim a State income tax credit for certain wages paid to the employee and for child care and transportation expenses paid on behalf of the employee in the first 2 years of employment. The Maryland General Assembly has passed a bill that repeals the termination date of the credit (previously June 30, 2013). This change is effective June 1, 2013. -3- B. Judicial Developments i. Taxpayer Loss in First Post-Gore Decision ConAgra Brands, Inc. v. Comptroller of the Treasury, No. 09-IN-OO-0150 (Md. Tax Ct. Feb. 24, 2015) The Maryland Tax Court issued its decision this week in ConAgra Brands Inc. v. Comptroller. In the case, which concerns the infamous intangible holding company issue in Maryland, the Comptroller asserted nexus over ConAgra Brands based on its licensing of intangibles to various operating companies that do business in Maryland. Although ConAgra Brands engages in substantial activity other than the licensing of intangibles (because it is responsible for the ConAgra group’s multi-million dollar national marketing and advertising program) the Tax Court decided the case in favor of the Comptroller. The Tax Court determined that ConAgra Brands lacked real economic substance as a separate business entity from its parent. It cited ConAgra Brand’s use of centralized ConAgra-wide services (such as legal, treasury function, and information services), shared corporate executives, and circular flow of funds as proof that Brands could not have functioned as a corporate entity without the support services it received from “corporate”. One positive result in the case is the Tax Court’s decision to abate interest from the date the taxpayer filed its appeal (February 2009) through the date of the Order (February 2015) and to abate all penalties. With $1.4 million in tax at issue, at a 13% interest rate on deficiencies, the abatement is meaningful. The taxpayer has filed an appeal to Anne Arundel County Circuit Court. ii. Maryland Separate Filing Requirement Does Not Prohibit the Taxing of a Corporation’s Federal Consolidated Return §311(b) Deferred Gain Where the Taxpayer Reports the Gain on its Maryland Tax Return NIHC, Inc. v. Comptroller of the Treasury, 97 A.3d 1092 (Md. 2014). This case is a continuation of the 2008 Maryland Tax Court case involving Nordstrom’s intangible holding companies – NIHC and N2HC. The income sought to be taxed by Maryland arose from a 1999 transaction, whereby NIHC distributed, as a dividend, a license agreement authorizing the right to license the use of Nordstrom trademarks, to its parent, N2HC. As a result of the dividend of the licensing agreement, NIHC recognized gain on the distribution of appreciated property pursuant to I.R.C. § 311 (b). Pursuant to Treasury regulation, NIHC was required to defer the reporting of the gain over the fifteen year period in which N2HC amortized the value of the license agreement under I.R.C. § 197. Approximately $186 million in deferred § 311 (b) gain was reported by NIHC each year in the 2002, 2003 and 2004 Nordstrom federal consolidated returns. It is those deferred amounts that the Comptroller sought to tax. In fact, on its 2002 and 2003 -4- Maryland tax returns, NIHC reported as Maryland modified income the $186 million in deferred §311(b) gain. NIHC argued that the deferred gain was reported in error and, based on separate filing rules, Maryland is prohibited from taxing the deferred gain. The Tax Court decided three issues. First, the Tax Court found a sufficient constitutional nexus between NIHC’s §311(b) gain and Nordstrom’s business activities in Maryland. Second, the Tax Court determined that NIHC’s §311(b) gain was subject to Maryland taxation because NIHC reported §311(b) deferred gain as Maryland modified income on its 2002 and 2003 Maryland income tax return. Third, the Tax Court ruled that, in light of the nexus between NIHC’s §311(b) gain and Nordstrom’s business activities in Maryland, Maryland’s separate reporting requirement did not prevent the Comptroller form taxing NIHC’s §311(b) deferred gain as reported on its 2002 and 2003 Maryland tax returns. On appeal, the Circuit Court affirmed the Tax Court’s decision on the first two issues, but reversed on the third issue, holding that Maryland’s separate filing requirement for corporations prohibited the taxing of NIHC’s §311(b) gain on a deferred basis. The Comptroller appealed to the Maryland Court of Special Appeals. The Court of Special Appeals held that because NIHC reported the §311(b) deferred gain as Maryland modified income on its 2002 and 2003 Maryland tax returns it was taxable. The court reasoned that nothing precludes Maryland from taxing income that is constitutionally taxable by Maryland and that is reported by the taxpayer as Maryland modified income on its Maryland tax return. The court did not express an opinion on the actual issue of whether Maryland’s separate filing regime prohibited taxation of the §311(b) deferred gain, reasoning that the facts of the case (namely, NIHC’s reporting of the deferred gain on its Maryland return) did not require the court to address the issue. The taxpayers appealed to the Court of Appeals, which upheld the decision of the Court of Special Appeals. The Court of Appeals determined that the income recognized by NIHC from the transactions had a connection to business activities of Nordstrom in Maryland during 2002 and 2003, that a portion of that income was reported on NIHC’s Maryland returns from 2002 and 2003 (which were never amended to reflect the taxpayer’s current theory), and that the income is taxable by Maryland. The court further noted that mistakes made by the taxpayer in preparing its Maryland tax returns did not entitle it to escape tax liability on the income. iii. Intangible Holding Company Nexus and the Unitary Business Principle Comptroller of the Treasury v. Gore Enterprise Holding, Inc. and Future Value, Inc., No. 36, September Term, 2013 (Md. March, 24, 2014). The Gore and Future Value cases resemble your typical intangible holding company case, with a slight twist – patents were involved. Both Gore and Future Value were subsidiaries of a common parent corporation. Gore -5- earned patent royalties based on a percentage of sales made by its parent corporation. Future Value earned interest income from loans made out of accumulated royalty profits that were transferred to it from Gore. The Comptroller asserted nexus over Gore and Future Value. The Tax Court held in favor of the Comptroller citing the usual – the companies were engaged in a unitary business; they had no economic substance; they depended on the operating parent company for assets and income; the royalty and interest income were directly connected with Maryland activity. In a bench ruling, the Circuit Court reversed the Tax Court. On appeal, the Maryland Court of Special Appeals reversed the Circuit Court, holding that patent royalties and interest income claimed as expenses in Maryland and paid to wholly-owned out-of-state subsidiaries are taxable as part of a unitary business. The Maryland Court of Appeals determined that the Maryland Tax Court was correct in holding that Maryland could tax GEH and FVI consistent with the Court of Appeals’ holding in Comptroller of the Treasury v. SYL, Inc. The court clarified that although the unitary business principle cannot be used to establish nexus over GEH and FVI, the subsidiaries nevertheless lacked economic substance as separate entities. The court pointed to the subsidiaries’ dependence on Gore for their income, the circular flow of money between the subsidiaries and Gore, the subsidiaries’ reliance on Gore for core functions and services, and the general absence of substantive activity from either subsidiary that was in any meaningful way separate from Gore as support for this finding. Although the Court of Appeal decision rejects the notion of a “unitary nexus theory”, the opinion notes that there’s no reason factors that indicate a unitary business cannot also be relevant in determining whether subsidiaries have no real economic substance as separate business entities. This statement seems to suggest there’s still a significant risk that the Maryland courts will continue to conflate the “unitary nexus” and “economic substance” theories, which could influence the outcome in a number of intangible holding company cases pending at the Maryland Tax Court and circulating at the Comptroller’s office at audit or in administrative review. iv. Comptroller’s Failure to Adopt Regulations and Equitable Tolling of Statute of Limitations Did Not Permit the Refund of Otherwise TimeBarred Refund Claims Ralph J. Duffie Trust FBO, et al. v. Comptroller of the Treasury, No. 11-INOO-1287 through -1294 (Md. Tax Ct. Aug. 15, 2013) The taxpayers, eight electing small business trusts (ESBTs) filed income tax refund claims. The trusts asserted that they inadvertently and/or erroneously overpaid their state income taxes during the years 1999 through 2008 by including in MD adjusted income amounts that should have been excluded as a result of the federal ESBT income bifurcation calculation. The Comptroller issued refunds for tax years 2006 – 2008, but denied the request for refunds for years prior to 2006 as barred by the 3-year statute of limitations. The taxpayers appealed the denial of the 1999-2005 years to the Maryland Tax Court. -6- On appeal, the taxpayers asserted that the Comptroller breached his affirmative duty under Tax-Gen. §2-103 to adopt reasonable regulations to administer the provisions of the tax laws and, as a result, the taxpayers paid tax on income that was not subject to state income tax. Consequently, the taxpayers argued, the Comptroller should not be permitted to deny a claim for refund based on the statute of limitations, and allow the state to be unjustly enriched by tax on income the Comptroller has conceded should not be subject to tax. The Tax Court held in favor of the Comptroller. It first determined that the Comptroller was not required to issue clarifying regulations regarding the federal statute at issue. Instead, the Court determined that §2-103 is intended to authorize the Comptroller to issue regulations as he deems necessary, rather than to require that he issue a regulation corresponding to the hundreds of provisions of the Tax-General article of the Maryland Code. Further, the court determined that even if it were to assume the Comptroller failed to perform its statutory duty, Maryland follows the “voluntary payment rule” with respect to tax refunds and, thus, there is no common law right to sue for a tax refund. To the extent a right to a refund exists, it must be found in statutory law. Because the taxpayers’ refund claims were filed after the three-year statute of limitations, the refunds were barred by statute. The court further held that that statute of limitations (which it determined operates as a statute of repose and a jurisdictional limitation) was not subject to equitable tolling. The taxpayers appealed the Tax Court’s ruling to the Circuit Court for Baltimore City, but subsequently filed a stipulation dismissing the case in January 2014. v. Rate Stabilization Credits Excluded from Computation of Public Service Company Franchise Tax State Department of Assessment and Taxation v. Baltimore Gas & Electric Company, No. 14, September Term, 2012 (Md. 2013). Baltimore Gas & Electric (“BGE”) was once the sole provider of electric power to customers in its service area. Maryland enacted legislation designed to introduce competition into the market for the supply of electric power. To facilitate the transition to a competitive market, the legislature enacted a rate stabilization plan, under which an anticipated increase in BGE’s rates for the supply of electricity would be mitigated through the application of credits and subsequent charges to residential customers’ bills. The legislation directed BGE to show the credits and charges on the distribution portion of a customer’s bill to make them nonbypassable. BGE took the position that placement of the credit on the customers’ bills had the effect of reducing its distribution income subject to the franchise tax. The Court of Appeals, however, held that the credits did not affect BGE’s distribution revenue or its liability for the franchise tax. The court reasoned that the credits were placed on the customers’ bill in order to make them nonbypassable so that BGE did not have a competitive advantage in the energy supply market and, thus, the legislature did not intend for the credits and charges to affect BGE’s franchise tax liability. -7- vi. County Tax Credit for Taxes Paid by Maryland Residents to Other States Based on Out-of-State Income Comptroller of the Treasury v. Wynne, No. 107, September Term, 2011 (Md. 2013) Maryland allows an individual subject to the Maryland income tax to take a credit against the state tax for similar taxes paid to other states. However, no credit is given against the county tax for income taxes paid in other states. The taxpayer was a Maryland resident and part owner of a Maryland S corporation who paid income taxes to 39 other states. The taxpayer reported pass-through income of the S corporation on his Maryland tax return (jointly filed with his wife). The taxpayer claimed his pro rata share of income taxes paid to other states as a credit against both his state and county Maryland individual income tax. The Comptroller denied the credit against the county income tax. The taxpayer appealed to the Maryland Tax Court, which upheld the Comptroller’s decision. On appeal the Circuit Court reversed and granted the credit finding that the failure to provide a credit violated the dormant Commerce Clause. The Comptroller appealed. The Maryland Court of Appeals affirmed the circuit court decision below and held that the failure to allow a credit against the county tax for out-of-state income taxes paid to other states on pass-through income earned in those states discriminates against interstate commerce and violates the Commerce Clause. The Court reasoned that the failure to provide a credit encourages interstate businesses to conduct more of their business within Maryland and favors in-state business in the raising of capital from Maryland residents because Maryland residents are taxed more highly on income earned out-ofstate. The Court determined that the failure to provide a credit made the tax both unfairly apportioned and discriminatory against interstate commerce. The Maryland Attorney General’s Office filed a petition for a writ of certiorari with the U.S. Supreme Court in October 2013. In January 2014, the high court invited the Solicitor General to file a brief in the case expressing the view of the United States. On April 4, 2014 the Solicitor General submitted its brief, urging the Court to hear the case. The U.S. Supreme Court, at the time of publication of this update, has not yet granted or denied cert in the case. C. Administrative Developments i. Designation and Renewal of Six Enterprise Zones The Maryland Department of Business and Economic Development (DBED) approved the designation and renewal of six enterprise zones. Maryland approved a new zone in Glenmont in Montgomery County, and redesignated zones in Cecil County, City of Cambridge-Dorchester County, Long Branch/Takoma Park – Montgomery County, town of Princess AnneSomerset County; and Southwest-Baltimore County. -8- DBED approves the State’s Enterprise Zones, while local governments are responsible for their administration. Businesses operating within an Enterprise Zone may be eligible for a tax credit towards their state income tax filings based upon the number of new jobs created, and a tax credit on their local real property taxes based upon their overall capital investment into a property. ii. Administrative Release No. 18: Net Operating Losses and Associated Maryland Addition and Subtraction Modifications Administrative Release No. 18 provides an overview of net operating losses and related addition and subtraction modifications as they relate to the computation of Maryland corporate income. The Release was updated July 2013, as a result of certain revisions to Maryland corporate income tax forms, to note changes in how and where taxpayers compute the NOL deduction with respect to certain Maryland modifications. According to the Release, beginning with tax year 2012 returns, the decoupling effect on the NOL deduction is no long calculated on Maryland From 500DM with the other decoupling modifications. Instead, a pro forma federal taxable income (FTI) is first computed to include the effect of other decoupling modifications, and then the pro forma NOL is applied to reduce the pro forma FTI to no less than zero. This amount is reported on MD Form 500, Line 5 (in a carryforward year) and is reported on Form 500X, Line 2b (in a carryback year). There has been some dispute as to whether this approach is available only for tax years 2012 and forward, or whether it is also properly applicable for prior tax years. II. TRANSACTIONAL TAXES A. Legislative Developments i. Transportation Infrastructure Investment Act (Regarding Motor Fuel Tax and Sales Tax Laws on Motor Fuel) The Transportation Infrastructure Investment Act increases transportation funding by making various amendments to Maryland’s motor fuel tax and sales tax laws. Two statutory revisions are discussed here. First, the bill imposes a 1% sales and use tax equivalent rate on motor fuel beginning July 1, 2013. The rate increases to 2% beginning January 1, 2015, and 3% beginning July 1, 2015. Unless federal legislation is enacted by December 1, 2015, authorizing the State to require remote sellers to collect Maryland sales and use tax, the rate will increase from 3% to 4% beginning January 1, 2016, and increase to 5% beginning in July 1, 2016. If federal legislation on sales tax collection is enacted and takes effect before December 1, 2015, the sales and use tax equivalent rate remains at 3% and the Comptroller is then required to distribute 4% of State sales and use tax revenues to the state’s Transportation Trust Fund. The legislation also indexes the motor fuel tax rates for all fuels, except for aviation or turbine fuel, to the annual change in the Consumer Price Index (CPI). Beginning July 1, 2013, motor fuel tax rates will increase annually if the Comptroller’s Office determines the CPI has increased over a specified -9- 12-month period. The increase will be the percentage growth in the CPI multiplied by the motor fuel tax rates, rounded to the nearest one-tenth of one cent. Motor fuel tax rates will remain unchanged if there is no increase in the CPI. Any increase in the rates may not increase by more than 8% of the tax rates imposed in the previous year. See HB 1515. ii. Communications Tax Reform Commission In 2012, the Maryland General Assembly established a Communications Tax Reform Commission to assess 1) the implications of a competitively neutral communications tax and fee system that eliminates the disparate treatment of similar communications service providers, and 2) the efficacy of tax and other incentives to encourage investment in broadband networks and emerging technologies. The Commission submitted its final report of its findings to the Governor and the General Assembly on June 30, 2013. Unfortunately, due to differences between member positions, the Commission was unable to arrive at any consensus recommendations for restructuring Maryland’s communications tax and fee structure. However, the final report does outline three policy proposals presented by various members of the Commission. The first proposal suggests reforming the telecommunications and pay-television tax and fee structure. The second proposal would exclusively reform the telecommunications industry. The final proposal focused on reforming the state’s tax and fee structure on communications services. The report also includes general outlines for reform from additional Commission members. iii. Sales Tax Exemption for Corporate Lodging Facilities The Maryland General Assembly passed a law that provides an exemption from certain hotel rental taxes and transient occupancy taxes imposed by certain counties for the sale of a right to occupy a room as a transient guest at a dormitory or lodging facility. To qualify for the exemption the facility must 1) be operated solely in support of a headquarters, training, conference, or awards facility, or the campus of a corporation or other organization; 2) provide lodging solely for employees, contractors, vendors, and other invitees of the corporation that owns the facility; and 3) not offer lodging to the general public. This law is effective June 1, 2013. iv. Prepaid Wireless E-911 Fee The Maryland General Assembly passed legislation that establishes a prepaid wireless E-911 fee of 60 cents per retail transaction, which must be collected by the seller from the consumer for each retail transaction in the State. The bill defines “prepaid wireless telecommunication service” as a commercial mobile radio service that allows a consumer to dial 911 to access the 911 system, must be paid for in advance, and is sold in predetermined units which decline with use in a known amount. Under the bill, a retail transaction occurs in the State if: 1) the sale or recharge takes place at the seller’s place of business located in the State; 2) the consumer’s shipping address is in the State; or 3) no item is shipped, but - 10 - the consumer’s billing address or the location associated with the consumer’s mobile telephone number is in the State. Before December 28, 2013, a seller may deduct and retain 50% of all collected prepaid fees for direct start-up costs. On and after December 28, 2013, the seller may deduct and retain 3% of the collected fees. The prepaid fee is the liability of the consumer and not the seller. However, the seller is liable for remitting all collected prepaid fees. Prior to the passage of this bill, 911 surcharges were imposed only on wired and wireless services – not prepaid wireless telecommunication services. The bill takes effect July 1, 2013. See SB 745. B. Judicial Developments i. Electricity Transmitting Equipment Did Not Qualify for Production Activity Exemption The Potomac Edison Co. v. Comptroller of the Treasury, No. 12-SU-OO-0644, -0645 (Md. Tax Ct. Jan. 22, 2015) The taxpayer is a utility company that provides electric service to customers in Maryland. The taxpayer filed a refund claim asserting that certain equipment it purchased (e.g. cables, transformers, substation equipment, distribution equipment, etc.) to transmit and distribute electricity to its customers is exempt from sales tax under the production activity exemption. The Comptroller denied the claim taking the position that only equipment used to generate electricity at the initial point of output is exempt under the production activity exemption. The Tax Court upheld the Comptroller’s denial determining that the transmission and distribution of electricity to consumers is not a production or manufacturing activity and, thus, the machinery and equipment used in the transmission of electricity did not qualify for the production activity exemption. C. Administrative Developments i. Taxable Price of Deal-of-the-Day Coupons The Comptroller amended Reg. 03.06.01.08, which defines “taxable price”, to address deal-of-the-day coupons. The Regulation provides that the “taxable price” includes the face value of any coupon issued by any person for which the vendor can be reimbursed or compensated in any form by a third party. This includes compensation in the form of advertising or promotion such as with an online deal-of-the-day eCoupon or similar discount. Thus, under the Regulation, a $50 deal-of-the-day coupon that permits a customer to purchase $100 worth of products at a store would be taxed on the $50 – not the $100. The Regulation also clarifies when there is no arrangement for a third party to reimburse the vendor, as in the case of a store coupon that in effect establishes a lower price, the coupon is not included in the taxable price. Reg. 03.06.01.08 also provides that consumer excise taxes are not included the taxable price. The amendments to the Regulation removed the - 11 - requirement that a buyer remain liable for payment of a consumer excise tax in order for the tax to be excluded from the taxable price. The changes are effective August 19, 2013. ii. Taxability of Mixed Tangible Personal Property and Service Lease or Rental Transactions The Comptroller took final action on an amendment to Reg. 03.06.01.28 regarding leases of tangible personal property. The Regulation was amended to provide specific guidance about the taxability of transactions that include a rental of tangible personal property and delivery of a service. The Regulation provides that sales tax applies to the entire lease payment, including service charges, if the dominant purpose of the transaction is to obtain the property and the service charge is a mandatory charge imposed by the vendor as a condition of renting the item or the service is incidental and is not the dominant purpose of the transaction. This applies whether the service component is separately stated or not (with exceptions for certain services specifically enumerated in the regulation). Similarly, tax does not apply to a charge for a service that includes a charge for a lease or rental of tangible personal property, whether or not the charge is mandatory or separately stated, if the dominant purpose of the transaction is to obtain a service and the provision of the tangible personal property is incidental to the service. This amendment is effective August 19, 2013. iii. Assumption or Absorption of Tax by Vendor The Comptroller took final action on amendments to two regulations concerning the assumption or absorption of sales tax by a vendor. First, the Comptroller amended Reg. 03.06.03.02, regarding recordkeeping, to provide that a vendor who elects to assume or absorb all or part of the sales and use tax on a retail sale must maintain records that distinguish sales in which the vendor assumed or absorbed tax. Second, the Comptroller amended Reg. 03.06.03.05, regarding refunds of sales and use tax, to address refund claims by a vendor who assumed or absorbed the sales and use tax on a sale. The amendment provides that a vendor who has assumed or absorbed sales and use tax on a retail sale or use may claim a refund of sales and use tax, interest, or penalty erroneously paid. The vendor’s records must show that the sales and use tax was separately stated from the sale price and conclusively demonstrate that the vendor paid the tax on behalf of the buyer. These changes are effective August 19, 2013. iv. Sales and Use Tax Refunds Involving the Collection Discount The Comptroller amended Reg. 03.06.03.05, regarding refunds of sales and use tax, to provide guidance regarding refunds involving a collection discount. - 12 - Maryland allows taxpayers who file their sales and use tax returns and pay their sales tax on a timely basis to keep a portion of the sales tax collected (up to $500) as a discount. The amendments to the regulation state that if the entire amount of the taxes previously paid with a return was subject to the collection discount, the Comptroller shall deduct from an approved refund the amount of the collection discount. If the previously paid tax amount was not subject to the collection discount, the Comptroller shall deduct the collection discount from an approved refund if, after excluding the refund from the total amount of tax previously paid, the taxpayer would not exceed the collection discount limitation. This amendment is effective August 19, 2013. v. Definition of Medical Equipment Expanded Maryland exempts certain medical equipment from sales and use tax. Regulation 03.06.01.09 has been amended to update the list of items included in the definition of “medical equipment” to include heart monitors and stairlifts that are not installed so as to become part of real property. The amendments also update the list of items not included in the definition of medical equipment to exclude blood pressure devices, thermometers, scales, and devices to obtain or monitor pulse or respiration. The amendments are effective August 19, 2013. vi. Presumption on Taxability of Propane Gas Containers Regulation 03.06.01.10, regarding (among other things) natural and artificial gas, has been amended to provide that propane gas containers less than 60 pounds are presumed to be for recreational, rather than residential, use and, are therefore subject to tax. The revised regulation also states that sales of propane gas in containers of any size are subject to tax if the majority of the usage is not for residential purposes. The amendment is effective August 19, 2013. III. PROPERTY TAXES A. Legislative Developments i. Transfer of Property Pursuant to IRC 368(a) Reorganization Senate Bill 106 provides an exemption from the recordation tax and the State transfer tax for a transfer of real property as part of a reorganization of a corporation under Internal Revenue Code §368(a). The bill is applicable to all instruments of writing recorded on or after July 1, 2014. This legislation directly addresses an issue that was recently decided by the Maryland Court of Special Appeals (and was pending at the time the legislation was enacted) See Super-Concrete Corporation v. SDAT, No. 887, Term 13 (Md. Ct. Special App. Feb. 27, 2015). ii. Transfer of Property Between Related Entities - 13 - The Maryland General Assembly passed a law that provides an exemption from the recordation tax and the State transfer tax for the transfer of real property between a parent business entity and its wholly owned subsidiary or between subsidiaries wholly owned by the same parent business entity if certain requirements are met. The bill also exempts from the recordation tax and the State transfer tax the transfer of real property between a subsidiary business entity and its parent business entity under certain circumstances. A business entity is defined as a limited liability company or corporation. The law takes effect July 1, 2013, and is applicable to all instruments of writing recorded on or after July 1, 2013. See SB 202 and HB 372. iii. Recordation Tax Exemptions The Maryland General Assembly passed legislation that amends section 12105(f) of the Tax-Property Article of the Maryland Code to impose a recordation tax on an indemnity mortgage or indemnity deed of trust that is given in connection with a guaranteed loan that is in the amount of $3 million or more (previously $1 million under 2012 legislation). The law also requires that a series of indemnity mortgages that are part of the same transaction must be considered as one for purposes of the recordation tax. Further, indemnity mortgages recorded before July 1, 2012 may be amended without incurring the recordation tax on the original loan amount. This law takes effect July 1, 2013. See SB 1302. B. Judicial Developments i. Recordation Tax Applicable to State Law Merger Super-Concrete Corporation v. State Department of Assessments and Taxation, No. 887, Term 13 (Md. Ct. Special App. Feb. 27, 2015). Maryland provides an exemption from transfer and recordation tax for conveyances made pursuant to a reorganization under IRC section 368(a), which describes a variety of tax-free reorganizations involving corporations. Silver Hill Materials II, LLC (“Silver Hill”), a Maryland limited liability company that elected to be treated as a corporation for federal income tax purposes, merged with and into Super-Concrete Corporation (the “Taxpayer”), a District of Columbia corporation. As a part of the merger, the Taxpayer filed a Certificate of Conveyance for real property that Silver Hill owned in Maryland that was included in the merger. The Taxpayer claimed an exemption from recordation and transfer taxes for the conveyance, claiming the conveyance was made pursuant to a reorganization under IRC section 368(a). SDAT denied the Taxpayer’s exemption claim and assessed recordation and transfer taxes, stating that IRC section 368(a) does not describe the merger of a LLC into a corporation. The Taxpayer paid the taxes and subsequently filed a request for refund. SDAT denied the request and the Taxpayer appealed to the Tax Court. - 14 - The Tax Court ruled in favor of SDAT determining that the merger was not exempt from the recordation and transfer taxes. The Court held that the recordation tax exemption only applies to entities that are considered to be corporations under Maryland law. Although Silver Hill elected to be treated as a corporation for federal income tax purposes, a LLC is not within the definition of a corporation under Maryland law. The Circuit Court for Baltimore City affirmed the decision of the Tax Court. However, the Maryland Court of Special Appeals reversed. The case has been remanded to the Tax Court for further proceedings consistent with the Court of Special Appeals’ decision. For instruments recorded on or after July 1, 2014, the Maryland General Assembly has provided a legislative fix to this issue by passing SB 106, which specifically exempts transfers of real property pursuant to an IRC §368(a) reorganization. ii. Federal Banking Associations Exempt from Recordation and Transfer Taxes Montgomery County, Maryland v. Federal National Mortgage Association, et. al., 740 F.3d 914 (4th Cir. 2014). Congress has exempted the Federal National mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) generally from state and local taxes, except for state and local taxes on real property. See 12 USC §1723a(c)(2) (as to Fannie Mae) and §1452€ (as to Freddie Mac) (collectively, the “federal exemption provisions”). The taxpayers, Fannie Mae and Freddie Mac, acquired real property in Maryland through foreclosures on mortgages that they owned or guaranteed. When selling these properties to third persons, the taxpayers refused to pay Maryland recordation and transfer taxes, claiming to be exempt from them under the federal exemption provisions. Montgomery County, Maryland (along with two counties in South Carolina) disputed the taxpayers’ claimed exemptions and sued the taxpayers, contending that the federal exemption provisions do not cover state and local transfer taxes, including recording fees, insofar as they related to real property. The counties argued that “real property” includes deeds to the property recorded by the taxpayers because deeds are indispensable to ownership of real property. The counties also argued that exempting the taxpayers from state and local transfer taxes for real property would be unconstitutional as an infringement on the States’ taxing power because transfer taxes at issue are purely intrastate in nature and the Commerce Clause does not authorize Congress to regulate local, intrastate activity. The U.S. District Court for the District of Maryland rejected the counties’ argument and determined that there is a distinction between property taxes and transfer taxes. It further concluded that the federal exemption provisions were a constitutional exercise of Congress’s Commerce Clause power. On appeal, the U.S. Court of Appeals for the Fourth Circuit affirmed the District Court decision. It also reasoned that the federal exemption provisions exempt the taxpayers from state and local taxes except for real - 15 - property taxes and transfer and recording taxes (which are taxes on certain privileges of ownership, such as the right to transfer real property) are distinct from real property taxes (which are taxes imposed on the ownership of real property). It further determined that Congress, pursuant to its Commerce Clause power, could exempt the taxpayers from state and local transfer taxes, even though they are collected in the context of intrastate transactions, because the taxes could substantially interfere with or obstruct the constitutionally justified missions of the taxpayers in bolstering the secondary mortgage market. iii. Property Tax Exemption Upheld for For-Profit Improvements on State Owned Property Townsend Baltimore Garage, LLC v. Supervisor of Assessments of Baltimore City, 79 A.3d 960 (Md. Ct. Spec. App. 2013). Maryland provides a real property tax exemption for real property owned by the State of Maryland. This case involves two parcels of land owned by the State of Maryland and leased to a non-profit corporation of the University of Maryland BioPark in Baltimore City (UMB). UMB subleased the two parcels to two for-profit entities (the “taxpayers”). One subtenant agreed to finance and construct an office and laboratory building on one parcel, and the other subtenant agreed to finance and construct a parking garage on the other parcel. Both sublease agreements provided that during the lease term, title to the improvements will be held by the subtenant. The sublease agreements further provided that upon expiration of the sublease term the sublandlord shall be the owner of the improvements free from any interest of the subtenant. The subtenants leased the 85% of the office space and 25% of the garage back to UMB for University purposes. The Supervisor of Assessments of Baltimore City (“Supervisor”) argued that although the State owns the underlying land, the land is subleased to two forprofit entities for use in connection with businesses that are conducted for profit and, thus, the leasehold interests are not subject to real property tax exemption. The Tax Court agreed with the Supervisor, concluding that because the taxpayers, pursuant to the sublease agreements, were the owners of the improvements and, generally the tax treatment of the improvements and the land are the same, the property was subject to property taxation. The Circuit Court for Baltimore City affirmed the decision of the Tax Court. On appeal, the Court of Special Appeals reversed the decision of the Circuit Court. It determined, based upon a 2011 Court of Appeal decision involving a similar issue, that the record owner, as listed in the land records, is the owner of real property for tax assessment purposes. The court further noted that ownership of the improvements generally follows title to the land. Thus, because the State is the owner of the underlying land, it is also deemed the owner of the improvements. The Court ruled that the stipulated percentage of the improvements used for University purposes remain exempt from real property taxes. - 16 - iv. Recordation Tax Exemption for MEDCO Maryland Economic Development Corporation v. Montgomery County, No. 44, September Term, 2012 (Md. 2013). The Maryland Legislature granted the Maryland Economic Development Corporation (“MEDCO”) an exemption from any requirement to pay taxes or assessments on its properties or activities, or any revenue from its properties or activities. MEDCO presented a deed of trust for recording in Montgomery County and claimed an exemption from the recordation tax based on the tax exemption granted by the legislature. Montgomery County however, argued that the legislature’s exemption does not include recordation taxes (because exemptions from all taxation are generally understood to apply only to direct taxes), that the recording of a deed of trust is not an “activity”, and that the recording of a deed of trust is not a “requirement”. The Maryland Court of Appeals disagreed and held in favor of MEDCO. The court determined that the plain meaning of MEDCO’s tax exemption includes an exemption from excise taxes, that recording the deed of trust was one of MEDCO’s activities, and that MEDCO was required to pay the recordation tax, by both its contract with the lender and by being the entity to present the deed to the County. Thus, MEDCO was exempt from the recordation tax. IV. MISCELLANEOUS / OTHER ITEMS OF INTEREST A. Legislative Developments i. Maryland General Assembly Declares Tax Amnesty The Maryland General Assembly passed legislation to enact a tax amnesty program from September 1 to October 30, 2015. Under the program, the Comptroller will waive all civil penalties and one-half of any interest for taxpayers who failed to file a return required or pay a tax imposed on or before December 31, 2014. The program is applicable to personal and corporate income, withholding, sales and use, and admission and amusement taxes. Any taxpayer that was granted amnesty under a Maryland tax amnesty program between 1999 – 2014 or was eligible for the July 1 – November 1, 2004 settlement period for tax years prior to 2003 (related to intangible holding companies) is not eligible to participate in the 2015 amnesty program. The last amnesty program (held in 2009) generated $38.9 million. See HB 1233 / SB 763. ii. Maryland General Assembly Retroactively Reduces Interest Rate for Refunds Resulting from a Wynne, Win The Maryland General Assembly passed legislation to retroactively reduce the state’s interest rate on income tax refunds that result from a final decision in Maryland State Comptroller of the Treasury v. Brian Wynne, et. al., 431 Md. 147 (Md. 2013). The legislation provides that the interest rate payable on such refunds (should the U.S. Supreme Court decline to hear the case or rules against the State) will be a percentage, rounded to the nearest - 17 - whole number, that is equal to the average prime rate of interest quoted by commercial banks to large businesses during fiscal 2015, based on a determination by the Board of Governors of the Federal Reserve Bank. Although the applicable average prime rate of interest for 2015 has yet to be determined, the average prime rate of interest quoted by commercial banks to large businesses as of March 2014 is 3.25%, far less than the 13% statutory rate of interest typically paid on refunds. See SB 172, Section 16. iii. Comptroller Must Disclose Usage of General Fund Dollars The Maryland General Assembly has passed legislation that requires the Comptroller to include a graph or picture on certain income tax forms representing how much of each general fund dollar received is spent on education, health, public safety, and any other category included by the Comptroller. See SB 604 / HB 743. iv. Disaster or Emergency Related Work Does Not Create Nexus The Maryland General Assembly has enacted legislation that clarifies that an out-of-state business that performs disaster or emergency related work in Maryland during a disaster period does not establish nexus with the state. A “disaster period” is defined as a period that begins 10 days before and 60 days after a declared state disaster or emergency. A business must provide the Comptroller with a statement that the business is in the state solely for purposes of performing disaster or emergency related work. To be considered an out-of-state business, the business entity must not have nexus or tax filings in the state prior to the declared state disaster or emergency. An outof-state business includes a business entity that is affiliated with a business in the state solely through common ownership. The law is effective June 1, 2013. See H.B. 1513. B. Administrative Developments i. Amendments to Hearings and Appeals Regulation The Comptroller amended Reg. 03.01.01.04, regarding appeals to the Office of Hearings and Appeals. Maryland requires appeals to the Office of Hearings and Appeals to be filed via a written application. The amended Regulation now defines the term “written application” and the definition includes written requests submitted via U.S. mail, facsimile, email or online appeal, or is delivered in person. The Regulation was also revised to address appeals of refunds intercepted by other states. In the event the Comptroller withholds a portion of an approved refund for a liability certified by the taxing official of another state, a taxpayer may submit a written application for a hearing to the Office of Hearings and Appeals within 30 days of the date of the notice of intercept, or request a hearing with the taxing official of the certifying state in accordance with the laws of the state that certified the liability. Other revisions to the Regulation include confirmation that a hearing officer may require documentation of the reason for an emergency request for - 18 - postponement of a hearing, guidelines regarding hearings conducted by electronic means, and updates to the sections addressing hearings regarding alcohol and tobacco licenses. The amendments are effective August 19, 2013. V. PROVIDER’S BRIEF BIOGRAPHY/RESUME A. Alexandra Eikner Sampson Alexandra is a member of Reed Smith’s State Tax Group in the Washington, D.C. office. Her practice includes state and local tax compliance, audits, appeals and litigation, with an emphasis on District of Columbia, Maryland and the Carolinas tax matters. She advises clients on complex multistate issues spanning the corporate income, franchise and business, sales and use, and property tax areas. Before joining Reed Smith, Alexandra was a fellow with the Council on State Taxation. She is a co-chair of the ABA/IPT Advanced Sales Tax Seminar, a former Vice-Chair of the Tax Law Committee of the ABA’s Young Lawyers Division, and is a member of the Maryland Chamber of Commerce Taxation Committee and Maryland Bar Association’s State Tax Study Group. - 19 - MARYLAND STATE DEVELOPMENTS ______________________________________________________________________________ KENNETH H. SILVERBERG CHRISTIAN M. MCBURNEY ROBERT G. TROTT NIXON PEABODY LLP 401 – 9th Street, NW #900 Washington, DC 20004-2128 202-585-8000 202-585-8080 facsimile [email protected] [email protected] website: http://www.nixonpeabody.com I. INCOME AND FRANCHISE TAXES A. Corporations, Financial Institutions, and Unincorporated Businesses 1. Maryland Health Enterprise Zone Tax Credits The Maryland Secretary of Health and Mental Hygiene has adopted new and amended regulations pertaining to the Health Enterprise Zone Tax Credits (Md. Regs. Code §§ 10.61.01.03, -.05, and -.06, effective 12/22/2014). The regulations establish procedures for implementation of the hiring tax credit available to certain health enterprise zone employers. B. Judicial Developments 1. Out-of-state Subsidiary Income The Maryland Tax Court has ruled that an out-of-state subsidiary corporation was subject to Maryland corporate income tax because it had sufficient contacts and the comptroller fairly apportioned income to the taxpayer's Maryland-related income-producing activities. Intellectual property from the parent and other subsidiaries were exchanged for taxpayer stock and the taxpayer managed, controlled, promoted, and marketed its brand names and trademarks as well as incurred legal and consulting fees protecting the trademarks, but had no employees, agents, or representatives present or engaged in activities in Maryland. In Maryland, nexus is sufficient to justify state corporate income taxation the parent's business in Maryland produced the income of the subsidiary. The taxpayer's royalty income for the licensed trademarks, which was paid back to the parent in the form of intercompany payments, is subject to Maryland income tax because the taxpayer lacked real economic substance as a business separate from its parent. The lack of economic substance is evidenced by the fact that the parent company controlled the taxpayer through stock ownership, functional integration, and common employees via directors and officers. With regard to apportionment, Maryland's 3-factor apportionment formula does not clearly reflect the income allocable to Maryland since the taxpayer did not record Maryland sales, payroll, or property, and, therefore, the comptroller's blended apportionment factor derived directly from the Maryland income tax returns of the parent's entities and the parent's own 15157249.1 -2apportionment figures, was appropriate and there was no clear and convincing evidence that this method was unfair. (ConAgra Brands, Inc. v. Comptroller, Md. Tax Ct., No. 09-IN-OO-0150, 02/24/2015.) ConAgra is the first case decided in the post-Gore era. It appears Maryland will use the common unitary indicia of centralization of management and functional integration to establish that subsidiaries lack economic substance separate from their parent. 2. Machinery and Equipment Exemption The Maryland Tax Court has ruled that the transmission of electricity is a taxable service and does not qualify for the machinery and equipment exemption because it is not a production activity. The taxpayer, Potomac Edison Company, contends that certain items it purchased in connection with the transmission of electricity in Maryland should be exempt from sales and use tax because the transmission of electricity that takes place in a generation plant continues in the transmission lines that delivers electricity to customers. In Maryland, the sales and use tax does not apply to a sale of tangible personal property used directly and predominantly in a production activity at any stage of operation on the production activity site. Further, the transmission of electricity is specifically included in the definition of “taxable service” and the generation of electricity is specifically included in the definition of “production activity.” In this case, the transmission of electricity is taxable because the processing that takes place in the transmission of electricity is not the same as the processing that takes place in the generation of electricity. (The Potomac Edison Co. v. Comptroller of the Treasury, Md. Tax Ct., Nos. 12-SU-OO-0644; 12-SU-OO-0645, 01/22/2015.) 3. Wynne v. Comptroller of the Treasury The U.S. Supreme Court will consider Wynne v. Comptroller of the Treasury, Md. Ct. App., Dkt. No. 107, September Term, 2011, 01/28/2013, 431 Md 147, 64 A3d 453 (2013). In Md. Comptroller of Treasury v. Wynne, U.S., No. 13-485, brief filed 9/19/14, Maryland resident Brian Wynne argued that the state's partial-credit tax scheme violates the dormant Commerce Clause by unfairly penalizing Maryland residents for making money across state lines. The law in question imposes both a state- and county-level tax on Maryland residents. In his merits brief, Wynne argued that Maryland's individual income tax scheme burdens interstate commerce by not providing a credit against the county tax for income taxes paid to other states. The Maryland Comptroller for the Treasury filed a brief in July arguing that it had a sovereign right to tax Maryland residents' income wherever earned. This position was supported in an August amicus brief filed by the U.S. Solicitor General. The Supreme Court will hear the comptroller’s appeal from a Maryland Court of Appeals ruling that residents who earn income from activities outside the state are treated differently than residents who engage in similar activities but earn all of their income in Maryland. There is no dispute about whether the state has the sovereign power to impose an income tax. However, Wynne argues the tax must yield when it offends the Commerce Clause. The Maryland Court of Appeals decision relied on Complete Auto Transit Inc. v. Brady, 430 U.S. 274 (1977), in holding the local tax failed the internal consistency test because Maryland taxpayers are subject to higher taxes than taxpayers in other states. Further, the Court 15157249.1 -3found the tax scheme also failed the external consistency test because income from outside the state is taxed in the state of origin and in Maryland, which is double taxation on the same income. Wynne contends this discourages small business owners and pass-through entities from offering their products and services to customers across state lines. C. Credits 1. Sustainable Communities Tax Credit Certifications The Maryland Department of Planning has adopted the repeal of the regulations pertaining to the sustainable communities tax credit certifications and has adopted new regulations to replace them (Md. Regs. Code §§ 34.04.07.01 through -.07 repealed and new §§ 34.04.07.01 through -.08 adopted, effective 02/16/2015). The new regulations conform to 2014 legislation that removed certain requirements and added options for small commercial projects to receive sustainable communities tax credit certifications. Previously, the Department was granted emergency status effective January 1, 2015 until June 30, 2015 for these regulations. Currently, they are permanently adopted effective February 16, 2015. 2. Maryland Regional Institution Strategic Enterprise Zone The Maryland Department of Business and Economic Development has adopted new regulations (Md. Regs. Code §§ 24.05.21.01 through .13, effective 03/30/2015) pertaining to the Regional Institution Strategic Enterprise (“RISE”) Zone Program. The regulations detail the requirements, procedures, and applications for designation as a “qualified institution” and as a RISE zone. Also, the person or entity identified in the target strategy for preparing the annual report must submit an annual report to the Department on a calendar year basis by April 15 of the following year, in the form and containing the information established by the Maryland Secretary of Business and Economic Development. 3. Maryland Health Enterprise Zone Tax Credits The Maryland Secretary of Health and Mental Hygiene has adopted new and amended regulations pertaining to the Health Enterprise Zone Tax Credits (Md. Regs. Code §§ 10.61.01.03, -.05, and -.06, effective 12/22/2014). The regulations establish procedures for implementation of the hiring tax credit available to certain health enterprise zone employers. II. ADMINISTRATIVE 1. Tax Liens – Exhaustion of Administrative Remedies The Maryland Court of Special Appeals has ruled that a company federally charged with money laundering and operating an illegal gambling operation, resulting in the Maryland Comptroller assessing deficient Maryland admissions and amusement taxes and fraud penalties for under-reported gross income, must exhaust all administrative remedies before appealing to the Maryland Tax Court. After a hearing officer reduced the taxes owed, the taxpayer continued to protest the assessment by appealing to the Maryland Tax Court. While this appeal was pending, the comptroller filed a notice of lien against the taxpayer, who filed a petition in the Circuit Court for Baltimore County asking that the tax lien be vacated. Although the issue in the 15157249.1 -4instant case was rendered moot (i.e., the Maryland Tax Court affirmed the assessment), the Maryland Court of Special Appeals ruled that the circuit court did not have the authority to vacate the lien because Maryland statutory law expressly prohibits courts from issuing an injunction or any other process enjoining or preventing the comptroller's collection of a tax (only in exceptional and narrow circumstances can a taxpayer obtain collateral recourse from the judiciary to prevent the assessment or collection of a tax). In this case, the comptroller, in exercising its broad powers bestowed by the Maryland General Assembly, confronted the possibility that the taxpayer's assets might be depleted during the pendency of the tax court appeal, that other creditors might initiate claims, or that more fraudulent acts might occur in choosing to file the lien before the tax court's final determination. (Comptroller v. Zorzit, Md. Ct. Spec. App., No. 883, September Term, 2013, 01/30/2015.) 2. Interest Rates for Refunds and Delinquent Taxes The Maryland Comptroller's Office has set the interest rates for refunds and delinquent taxes. The annual interest rate for overpayments and underpayments of taxes for calendar year 2015 remains at 13%. (General Notice, Maryland Comptroller of the Treasury, Maryland Register Vol. 41, Issue 21, p. 1299, 10/17/2014.) III. 15157249.1 BRIEF BIOGRAPHY/RESUME OF PROVIDERS A. CHRISTIAN M. MCBURNEY (B.A., magna cum laude, Brown University 1981; J.D. & Law Review, New York University School of Law 1985; LL.M Georgetown University Law Center, Taxation, 1992) is a partner with the Washington, DC Office of Nixon Peabody LLP. Former chair and vice-chair of the State and Local Tax Committee of the Taxation Section, District of Columbia Bar; coeditor-in-chief of the Journal of Multistate Taxation. A. KENNETH H. SILVERBERG (B.A. (Economics), University of Michigan, 1968; J.D., Georgetown University Law Center, 1973) is a partner with the Washington, DC Office of Nixon Peabody LLP. B. ROBERT G. TROTT (B.A, University of Virginia, 2000; MFA, Queens University, 2006; J.D., University of Michigan Law School. 2012) is an associate with the Washington, DC Office of Nixon Peabody LLP. MASSACHUSETTS STATE DEVELOPMENTS Spring 2015 www.reedsmith.com/MAtax; www.MassachusettsSALT.com Michael A. Jacobs Reed Smith LLP Three Logan Square 1717 Arch St., Ste. 3100 Philadelphia, PA 19103 Phone: 215-851-8868 [email protected] Robert E. Weyman Reed Smith LLP Three Logan Square 1717 Arch St., Ste. 3100 Philadelphia, PA 19103 Phone: 215-851-8160 [email protected] Brent K. Beissel Reed Smith LLP Three Logan Square 1717 Arch St., Ste. 3100 Philadelphia, PA 19103 Phone: 215-851-8869 [email protected] For additional information, articles, and presentations, see www.reedsmith.com/matax. I. Corporate Excise Tax A. Legislative Developments Market sourcing and throwout effective January 1, 2014: Massachusetts enacted legislation replacing Massachusetts’ cost-of-performance sourcing regime for receipts from sales other than sales of tangible personal property. The new law implements market sourcing and a throwout rule for sales other than sales of tangible personal property for tax years beginning on or after January 1, 2014. Under the new market sourcing rule, receipts from sales other than sales of tangible personal property are sourced to Massachusetts as follows: (i) Sales, rentals, leases or licenses of real property are sourced to Massachusetts if the property is located in the Commonwealth; (ii) Rentals, leases or licenses of tangible personal property are sourced to Massachusetts if and to the extent the tangible personal property is located in the Commonwealth; (iii) Sales of services are sourced to Massachusetts if the service is delivered to a location in the Commonwealth; (iv) Leases or licenses of intangible property are sourced to Massachusetts if the intangible property is used in the Commonwealth; (v) Sales of intangible property, if receipts are contingent on the productivity, use, or disposition of the intangible, are sourced to Massachusetts to the extent the intangible property is used in the Commonwealth; and (vi) Sales of intangible property, where the property sold is a contract right, government license, or similar intangible property that authorizes the holder to conduct a business activity in a specific geographic area are sourced to Massachusetts if the intangible property is used in or otherwise associated with the Commonwealth. The legislation also institutes a throwout rule for certain sales. Under this rule, sales are excluded from the sales factor if the taxpayer is not taxable in a state to which a sale is assigned under the new market sourcing rules, or if the state to which such sales should be assigned cannot be determined or reasonably approximated. Ch. 46, Acts of 2013, amending G.L. c. 63, § 38(f). Furthermore, the statute expands the class of receipts from intangible property that is excluded from the sales factor. Any receipts from intangibles that are not covered by I.A.1.(iv)–(vi) above are excluded from the sales factor. COST Semiannual update Spring 2015 04/14/2015 10:46 AM On January 2, 2015, the Department of Revenue (“Department”) released final regulations to implement the new sourcing rules. These regulations are discussed below in I.C.1. Utility excise tax repealed: For tax years beginning on or after January 1, 2014, utility companies formerly subject to the 6.5% excise tax on net income will be taxed as business corporations for corporate excise tax purposes. As a consequence, utility companies will now be subject to tax on the grater of: (1) the sum of 8% of net income plus $2.60 per $1,000 of value of taxable tangible property located in Massachusetts (tangible property corporations), or net worth (intangible property corporations); or (2) $456. Utility companies formerly subject to the public utilities excise tax will now apportion their income using the standard apportionment formula (property, payroll, and double-weighted sales), and they will also be able to carry forward losses generated in taxable years beginning on or after 2014. Any losses incurred by a utility for years prior to 2014 will not be available to be carried forward. Ch. 46, Acts of 2013. Research and Development Credit Expanded: On August 13, 2014, Governor Deval Patrick signed an $80 million economic development bill into law. The law includes an expansion of the research and development credit. For calendar years 2015, 2016, and 2017, taxpayers may now elect to take a credit equal to 5% of its qualified research expenses that exceed 50% of the taxpayer’s average qualified research expenses for the previous three years. The credit will be increased to 7.5% for 2018, 2019, and 2020; and then increased to 10% for years thereafter. If the taxpayer did not have qualified research expenses in any one of the three taxable years preceding the year for which the credit is claimed, the credit equals 5% of the taxpayer’s qualified research expenses for the year for which the credit is claimed. The term “qualified research expense” is defined under IRC § 41. These provisions only apply to qualified research expenses conducted in the Commonwealth. Ch. 287, Acts of 2014. Corporate tax amnesty program authorized: On February 13, 2015, Governor Charlie Baker signed legislation authorizing a corporate tax amnesty program, which will run during a twomonth period ending on or prior to June 30, 2015. The Department has provided guidance to taxpayers regarding eligibility for the program and the period during which the amnesty will be available, which is discussed at I.C.2 below. Ch. 2, Acts of 2015. B. Judicial Developments ATB finds nexus for biotechnology company owning drugs being studied in Massachusetts: On November 17, 2014, the Appellate Tax Board (“ATB”) promulgated Findings of Fact and Report in which the ATB held that a corporation doing business in Massachusetts was not entitled to claim the protection of P.L. 86-272 because it owned property in the Commonwealth and, therefore, was subject to Massachusetts’ corporate excise tax. The corporation was a biotechnology company headquartered in California that developed and sold therapeutic drugs. The corporation appealed an assessment of corporate excise tax, arguing that its activities in Massachusetts were limited to the solicitation of sales and, thus, were protected by P.L. 86272. The ATB found that, for the years at issue, the corporation (1) shipped large quantities of drugs to a third-party manufacturer in Massachusetts that encapsulated the drugs and sent them back to the corporation ready for commercial sale; (2) sent drugs to third-party clinical researchers in Massachusetts, who conducted clinical trials in Massachusetts on the corporation’s behalf; and (3) owned machinery and equipment located in Massachusetts. The corporation retained title to the drugs throughout these research and manufacturing activities. The ATB found that, based on the continuous presence of the property owned by the corporation in Massachusetts, the corporation was subject to corporate excise tax in Massachusetts. With respect to the clinical trials, the ATB did not attribute the activities of the third-party clinical researchers to the taxpayer—it focused only on the taxpayer’s ownership of the drugs 2 used by the researchers. Further, the ATB did not address whether the taxpayer’s detailing activities went beyond the protections of P.L. 86-272. The taxpayer has appealed the ATB’s decision to the Appeals Court. The taxpayer’s brief is due April 13, 2015. Genentech, Inc. v. Commissioner, ATB Docket Nos. C282905; C293424; C298502; and C298891 (Mass App. Tx. Bd. November 17, 2014). appeal pending, Mass App. Ct. Docket No. 2015-P-0287. The ATB Upholds Single-factor Apportionment for Manufacturers in Genentech: Separate from the P.L. 86-272 issue in Genentech v. Commissioner, discussed above, the taxpayer also challenged the Department’s classification of the taxpayer as a manufacturer and the resulting assessment from applying the statutory single-factor apportionment for manufacturers. Massachusetts law requires manufacturing corporations to apportion their income using a single sales factor.1 As a preliminary matter, the taxpayer argued that it was not a manufacturer. The taxpayer developed its drugs by injecting animal or bacteria cells with DNA molecules, causing the cells to produce certain types of proteins. The taxpayer then sold these proteins as therapeutic drugs. The taxpayer analogized its activities to that of a farmer: just as a farmer harvests crops and sells them, the taxpayer harvested proteins and sold them. The ATB labelled that analogy “facile at best,” pointing out that the taxpayer extracted and purified the proteins by subjecting the cells to physical change, in order to create a product fit for consumption. The ATB found that this process constituted manufacturing. The taxpayer then argued that even if it did engage in manufacturing, it was not a “manufacturing corporation” subject to single-factor apportionment. By statute, a taxpayer is a “manufacturing corporation” if it derives 25% of its gross receipts from the sale of goods that it manufactures.2 For purposes of this test, the taxpayer argued that “gross receipts” includes gross receipts from the maturity or redemption of short-term securities that the taxpayer generated through its treasury function. The ATB agreed that the plain language of the statute supported the taxpayer’s position, but nevertheless held that the gross receipts at issue must be excluded because to hold otherwise would lead to an “absurd result.” According to the ATB, the legislative intent behind the 25% test was to determine whether a taxpayer’s manufacturing activities were a substantial part of its business. The ATB found that the inclusion of gross receipts generated by the taxpayer’s treasury department— roughly 90% of its total gross receipts for the years at issue—would subvert that intent. The taxpayer has appealed the ATB’s decision to the Appeals Court. The taxpayer’s brief is due April 13, 2015. Genentech, Inc. v. Commissioner, ATB Docket Nos. C282905; C293424; C298502; and C298891 (Mass App. Tx. Bd. November 17, 2014). appeal pending, Mass App. Ct. Docket No. 2015-P-0287. Interest deductions on intercompany debt: The ATB issued another decision denying truedebt treatment for intercompany obligations. The ATB upheld assessments denying National Grid’s3 interest deductions for payments under deferred subscription arrangements (“DSAs”) on the basis that the DSAs did not qualify as true debt. The ATB also upheld the Department’s decision to add back the DSAs in computing National Grid’s net worth, which resulted in additional tax under the net worth component of Massachusetts’ corporate excise tax. The DSAs were refinancing instruments used by National Grid as part of its purchase of several US energy companies. When National Grid purchased a US energy company, it would initially finance the purchase with a loan from the global parent of the affiliated group, a UK entity (“UK Parent”). 1 M.G.L. c. 63, § 38(l). M.G.L. c. 63, § 38(l)(1). 3 The appeals involved three affiliated entities; for purposes of this outline, we are referring to the three entities collectively as “National Grid”. 2 3 After a corporate reorganization to integrate a newly acquired company, National Grid would become the obligor under the loan from UK parent. National Grid would then enter into a DSA with an affiliated special purpose entity (“SPE”), whereby it agreed to purchase shares in the SPE. The DSA would require National Grid to make a small initial payment, and then agree to make “call payments” to the SPE equal to the amount of the initial loan from the UK Parent plus additional amounts. National Grid characterized these additional amounts as interest payments and characterized the DSAs as debt. National Grid would then sell its shares in the SPE to a different affiliate for an amount that permitted repayment of the loan to UK parent, but National Grid would retain its obligation to make the call payments pursuant to the DSAs. National Grid treated the DSAs as debt when computing its net worth and deducted payments under the DSAs as interest in computing its federal taxable income. This treatment was consistent with the characterization of the DSAs as debt in National Grid’s financial statements and filings with the U.S. Securities and Exchange Commission. While the DSAs were not in the form of traditional loan documents, National Grid argued that, in substance, the DSAs operated as debt because: (1) they had a fixed maturity date; (2) the SPE had a legally enforceable right to the call payments; and (3) there were penalty, interest, and other enforcement mechanisms that the SPE could employ if National Grid did not make the call payments. Furthermore, National Grid did ultimately make call payments equal to the initial loan amount from UK Parent plus additional amounts that it argued were “interest” payments that reflected interest it would have been charged if it had financed the transaction through a third-party loan. The ATB ultimately rejected the taxpayer’s argument. It found that DSAs were not true indebtedness because although the SPE had a legally enforceable right to demand payment, the taxpayer was not under an unconditional obligation to pay. Accordingly, the Board found in favor of the Commonwealth.4 National Grid Holdings, Inc., et. al. v. Commissioner, Docket No. C292287–89, 2014 WL 2535189 (Mass. App. Tax Board, June 4, 2014) appeal pending, Mass App. Ct. Docket No. 2014-P-1662. In a separate appeal, the Board found that the taxpayer could not challenge the Commissioner’s denial of deductions for its interest payments based on the treatment of those payments in a closing agreement with the IRS. As discussed above, the Department denied National Grid’s interest deduction for payments to the SPE for the 2002 tax year and issued an assessment. Subsequent to National Grid’s appeal of that assessment, the taxpayer resolved a federal tax audit for the same tax year through a closing agreement. The closing agreement allowed the taxpayer to deduct a portion of its interest payments to the SPEs. Following the agreement, the taxpayer filed a separate application of abatement, this time challenging the Commissioner’s audit assessment based upon the terms of the taxpayer’s closing agreement with the IRS. The Commissioner took no action with respect to the second application for abatement; as a result, the taxpayer appealed to the Board. The Board noted that a taxpayer may not file a second application for abatement that challenges an item of tax that has already been challenged in a previous application, unless warranted by a change in fact or law. The taxpayer argued the IRS closing agreement created sufficient grounds for a second application, because the Department was bound by the IRS closing agreement, specifically the allowance of interest deductions. The Board disagreed, holding that the Commissioner was not bound by the closing agreement. Although Massachusetts net income is premised on federal net income, the Court noted that the dollar amounts for each need not match. Accordingly, it granted the Commissioner’s motion to dismiss the appeal. National Grid USA Service v. Commissioner, Docket No. C314926, (Mass. App. Tax Board, Sept. 19, 2014) appeal pending, Mass App. Ct. Docket No. 2014-P-1861. 4 The ATB ruled for the taxpayer regarding the treatment of an intercompany loan (separate from the DSA) as debt. The Department had conceded this issue in its brief. 4 National Grid appealed both ATB decisions to the Appeals Court, and has submitted briefs. The Commissioner’s briefs are due May 29, 2015. Securitization entity qualifies as financial institution: The ATB issued a decision that provides insight into the treatment of bankruptcy remote entities that are used for securitization transactions. The appeal involved Gate Holdings, a wholly owned subsidiary of First Marblehead Corporation. Gate Holdings held beneficial interests in trusts that purchased and held securitized student loans initially issued by third parties. The Department contended that Gate Holdings did not qualify as a “financial institution” for corporate tax purposes. The ATB rejected the Department’s argument, holding that Gate Holding was properly classified as a financial institution because it was engaged in lending activity (through its trust subsidiaries) that was in substantial competition with other financial institutions. See M.G.L. c. 63 § 1 “Financial institution” (e). Purchasing loans is a "lending activity": In reaching its determination, the ATB Expansive definition of "substantial competition": In interpreting the "substantial broadly applied the term “lending activity”, finding that although Gate Holdings and its trusts did not issue loans to the public, Gate Holdings still engaged in a lending activity because the trusts it owned purchased and held student loans. competition" requirement, the ATB found that banks also engaged in similar transactions involving the securitization of loans, and that such transactions facilitated lending by the banks. The ATB further noted that the purchase and securitization of loans by Gate Holdings and its affiliates reduced the investment opportunities available to other banks and financial institutions. Thus, the ATB determined that Gate Holdings and its affiliates were in substantial competition with other financial institutions. The ATB rejected the Department’s argument that the "substantial competition" prong was satisfied only if the taxpayer directly competed with other financial institutions to purchase the specific loans in its portfolio. The taxpayer appealed the ATB’s decision, but the Department did not challenge the ATB’s determination that Gate Holding’s is a financial institution—see I.B.5 for further information regarding additional issues in the appeal. First Marblehead Corp. & Gate Holdings, Inc. v. Commissioner, Docket Nos. C293487, C305217, C305240, C305241 (Mass. App. Tax Board, April 17, 2013), aff’d on other grounds First Marblehead Corp. v. Commissioner, 470 Mass. 497 (2015). ATB applies economic-nexus analysis in determining whether taxpayer is eligible for apportionment, but does not take into account activities of third-party contractors: The First Marblehead & Gate Holdings decision, see I.B.4 above, also provided guidance regarding a financial institution’s eligibility for apportionment and the sourcing of the institution’s loan portfolio for property-factor purposes. Significantly, the ATB held: Economic nexus standard applied to determine whether taxpayer is "taxable" in another jurisdiction: Gate Holdings had no payroll or receipts, and no property other than the student loans it purchased. Nonetheless, the ATB held that Gate Holdings was entitled to apportion its income because it held loans made to borrowers in all 50 states, and the presence of those borrowers would permit those other states to impose tax on Gate Holdings—presumably under Massachusetts’ economic-nexus standard. Third-party activities are not considered in sourcing loans for property-factor purposes: For financial institutions, a loan is included in the property factor and sourced to the regular place of business where the preponderance of the "SINAA"5 activities occur with respect to the loan. Gate Holdings argued that in determining 5 The SINAA activities with respect to a loan are solicitation, investigation, negotiation, approval, and administration. See G.L. c. 63, § 2A(e)(vi)(3)(C). 5 where the SINAA activities occurred with respect to its loans, it should be permitted to take into account the location of activities conducted by the third-party loan servicers under contract with Gate Holdings. The ATB rejected this argument because it did not consider the loan servicers to be agents of Gate Holdings. Instead, the ATB concluded that Gate Holdings did not have a regular place of business, either inside or outside of Massachusetts, and sourced the loans to Gate Holding’s commercial domicile in Massachusetts. Third-party activity insufficient to establish taxpayer is “taxable” in other jurisdictions: The taxpayer also argued that activities of its third-party loan servicers were sufficient to cause Gate Holdings to be subject to tax in states other than Massachusetts. The ATB rejected this argument on the basis that no agency or other relationship existed between Gate Holdings and the third parties sufficient to attribute the activities of the servicers to Gate Holdings. If the ATB had not rejected this argument, the Department could have used the same theory to assert that outof-state taxpayers were similarly "taxable" in Massachusetts based on the Massachusetts activities of unrelated third parties, based merely on the fact that those third parties were paid by the taxpayers. The taxpayer appealed to the Massachusetts Appeals Court; however the Supreme Judicial Court took the case sua sponte. After hearing oral argument on October 7, 2014, the Supreme Judicial Court upheld the ATB’s decision that Gate Holdings was required to source 100% of the value of its loan portfolio to its commercial domicile for purposes of computing its property apportionment factor because Gate did not originate or service the loans, and thus, it had no SINAA factors. Therefore, all of the loans were sourced to Gate’s commercial domicile—Massachusetts. First Marblehead Corp. & Gate Holdings, Inc. v. Commissioner, Docket Nos. C293487, C305217, C305240, C305241 (Mass. App. Tax Board, April 17, 2013), aff’d, First Marblehead Corp. v. Commissioner, 470 Mass. 497 (2015). C. Administrative Developments Department releases final market sourcing regulations: On January 2, 2015, the Department released final regulations implementing the new market-sourcing laws for sales other than the sale of tangible personal property. See I.A.1. The regulations provide specific sourcing rules based on the characterization of a sale. (i) Sourcing of receipts from services: The regulations specify three types of services, each with its own sourcing rules. (1) In-Person Services: These services are those that are physically provided in (2) Professional Services: These are services that require specialized knowledge (3) Services Delivered to the Customer or Through or on Behalf of the Customer: person, such as cleaning, medical, and repair services. They are sourced to the state where the services are performed. and in some cases require a license, degree, or professional certification. Sales to individuals are sourced to the customer’s state of primary residence. Sales to businesses are sourced to the state where the contract of sale is principally managed by the customer. Receipts from financial institutions which are not covered by the existing Financial Institution Excise Tax sourcing rules, such as broker’s fees, are sourced under the rules for professional services. These are services that are neither in-person services nor professional services. These receipts are sourced to the state where the service is 6 delivered or received, depending on (1) the delivery method (electronic or tangible) and (2) the nature of the customer (individual or business). (ii) Sourcing of receipts from the licensing of intangibles: The regulations distinguish between the licensing of marketing, production, and mixed intangibles. (1) Licensing of Marketing Intangibles: These are licenses granted for the right to use intangible property in connection with the sale, lease, license, or other marketing of goods, services, or other items. Royalties or other licensing fees paid by the licensee for such right are sourced to Massachusetts to the extent that the fees are attributable to the sale or other provision of goods, services, or other items purchased or otherwise acquired by customers in Massachusetts. (2) Licensing of a Production Intangible: These are licenses granted for the right (3) License of a Mixed Intangible: These are licenses that include both licenses for marketing and production intangibles. Fees attributable to the license of mixed intangibles are presumed to be for the license of marketing intangibles, and are sourced accordingly, unless the fees are separately stated in the licensing agreement. (4) License of an intangible that resembles a sale of an electronically-delivered good or service: These are sales that do not involve the license of a marketing to use intangible property other than in connection with the sale, lease, license, or other marketing of goods, services, or other items, and the license is to be used in a production capacity. The licensing fees paid by the licensee for the right of use are sourced to Massachusetts to the extent that the use for which the fees are paid takes place in Massachusetts. or production intangible. Examples include the sale of digital goods, database access, or certain electronically delivered software. Receipts attributable to these sales are sourced as though they are derived from sales of services delivered directly to the customer through electronic delivery. See I.C.1(ii)(3). (iii) Sourcing receipts from the sale of intangibles: The regulations implement different sourcing rules depending on the type of sale: (1) Contract Right or Government License that Authorizes Business Activity in Specific Geographic Area: Receipts are sourced to Massachusetts if and to the extent that the right or license is used or otherwise associated with Massachusetts. (2) Agreement Not to Compete: Receipts are sourced to Massachusetts if and to (3) Sales where the payment is based on productivity, use, or disposition of the intangible property: These sales are treated as licenses and sourced in the extent that the U.S. geographic area governed by the contract is in Massachusetts. accordance with the rules discussed above in I.C.1.(vii). (4) (iv) Receipts from all other sales of intangibles are excluded from the sales factor. Licenses of software transferred on a tangible medium: Licenses of software transferred to the licensor on a disk or other tangible medium are treated as sales of tangible personal property. The regulations provide an exception to this rule for licenses to duplicate the software, which would likely be treated as production, marketing, or mixed intangibles. See I.C.1(ii). 7 (v) Rules of Reasonable Approximation: If the state to which a sale is attributed under the specified rules cannot be determined, the taxpayer must source sales by a method of reasonable approximation. The taxpayer may use the approximation method of its choice (subject to the Department’s review). However, the draft regulations provide that the taxpayer’s choice becomes final once the return is submitted: the taxpayer cannot modify its approximation method by filing an amended return or an abatement claim under the draft regulations. The draft regulations also provide that the taxpayer must use the same approximation method consistently from year to year. Should the taxpayer wish to modify or change its approximation method, the taxpayer must obtain the Department’s approval. (vi) Throwout Rules: Throwout is required for the following sales: (1) Sales other than sales of tangible personal property where the taxpayer is not taxable in the state to which the sale is assigned; (2) Sales other than sales of tangible personal property where the Department determines that the taxpayer’s method of reasonable approximation is unreasonable (unless Department substitutes its own “reasonable approximation method); (3) Sales of securities, goodwill, going concern value, and workforce in place; (4) Sales of patented technology (unless the purchaser’s payments are based on the productivity, use, or disposition of the patented technology); (5) Sales of other intangible property, unless specifically included in the factor (as discussed above in I.C.1.(ix)); and (6) Sales other than sales of tangible personal property where the taxpayer cannot determine or reasonably approximate the state to which a sale should be assigned. The final regulations followed a working draft of the regulations which was released in March 25, 2014, and proposed regulations released on October 30, 2014. The substantial changes from the proposed draft to the final regulation include: (1) reductions to the thresholds taxpayers must meet to qualify for safe harbors that permit the sourcing of receipts based on the customer’s billing address; (2) expansion of certain safe harbors to apply to professional services; (3) addition of specific bases for the Commissioner to audit and adjust a taxpayer’s sourcing methodology; and (4) substantial revisions to the sourcing rules for transportation receipts. 830 CMR 63.38.1: Apportionment of Income (revised January 2, 2015). Department releases detailed guidance for corporate excise tax amnesty program: The Department released a technical information release specifying the administrative details of the amnesty program authorized by the legislature. The amnesty period is open now through May 15, 2015, for eligible taxpayers who owe corporate excise taxes (business corporations, as well as financial institutions, and insurance companies); estate taxes; fiduciary income taxes; and individual use tax on motor vehicles. Any tax that was covered by the amnesty program offered last fall is ineligible. A taxpayer with an outstanding assessment is eligible for the amnesty program if the taxpayer has an assessment of an unpaid and self-assessed tax liability stated on a bill issued by the Commissioner on or before January 1, 2015 or a tax liability assessed by the Commissioner dated on or before January 1, 2015 that remains unpaid. All other taxpayers are eligible if the taxpayer is a corporation, and the taxpayer is in compliance with the requirement to file an annual report imposed by the Secretary of State. An eligible taxpayer who participates in the Amnesty Program will not be eligible to participate in any future tax 8 Amnesty Programs for a period of ten consecutive years, beginning with calendar year 2015. The Department intends to notify taxpayers that are eligible to participate in the program. The following taxpayers are not eligible to participate in the amnesty program: (1) Any taxpayer engaged in pending litigation with the Commissioner if, as of March 16, 2015, the Appellate Tax Board or any court of law has made a determination in the Commissioner’s favor with regard to the issue being litigated, where (i) such determination relates either to the pending period or (ii) such determination relates to a prior tax period and the Commissioner concludes that the contested issue in the current period is substantially identical to the issue upon which the determination was made for the prior period; (2) Any taxpayer who has been or is the subject of a tax-related criminal investigation or prosecution; (3) Any taxpayer who has delivered or disclosed a false or fraudulent application, document, return or other statement. (4) Any taxpayer, with respect to tax periods regarding which the taxpayer has signed a settlement agreement with the Commissioner including, without limitation, any settlement reached through the Department’s Litigation Bureau, Office of Appeals, or Offer-in-Settlement Unit; and (5) Any taxpayer, with respect to tax periods covered by a settlement agreement, who still owes or is properly disputing penalties with regard to an assessment for those periods at the start of the amnesty period. In order to receive a full waiver of penalties under the amnesty program, a taxpayer must pay tax and interest in full for a particular tax type and period. In addition, a taxpayer participating in the amnesty program must agree to waive any right to claim a refund of any amounts paid pursuant to the program. In exchange, the taxpayer will be granted amnesty for unpaid penalties associated with such tax type and period. Tech. Information Release 152: Limited Amnesty Program for Taxpayers with Certain Tax Liabilities (March 16, 2015). Department issues draft directive to provide guidance on basis adjustments for Investment Tax Credit and Economic Development Incentive Credits: The Department released a working draft directive to assist taxpayers in calculating the basis of qualified property for purposes of the Investment Tax Credit and certain Economic Development Incentive Credits to properly reflect federal bonus depreciation under IRC §§ 167 and 168, and elections under IRC § 179. Corporations qualifying as manufacturing corporations, research and development corporations, or corporations engaged in agriculture or commercial fishing are allowed to take the Investment Tax Credit to offset corporate excise taxes. The amount of the credit is 3% of the “cost or other basis for federal income tax purposes” of qualifying tangible property.6 In addition, Economic Development Incentive Credits are general tied to qualified property under the investment tax credit. The draft directive provides that, when calculating the “cost or other basis for federal income tax purposes” for purposes of the credits, no adjustment is required on the basis that federal bonus depreciation was elected on the qualified property. However, where a taxpayer elects for federal purposes to deduct the expense of the cost of the property under IRC § 179, a similar reduction in the basis is needed for purposes of calculating the Investment Tax Credit, and, by incorporation, Economic Development Incentive Credits. The credits, can only be claimed on the remaining basis for federal tax purposes after the deduction allowed under IRC § 179. Working Draft 6 M.G.L. c. 63, § 31A(i). 9 Directive 15-XX: Determining Basis for Purposes of Calculating the Massachusetts Investment Tax Credit and Certain Economic Development Incentive Credits – Impact of Depreciation and Expensing Deductions (March 20, 2015). Department issues directive 14-4, denying deductions to corporate taxpayers: The Department released Directive 14-4, which states that if a taxpayer elects to take a credit instead of a deduction for purposes of computing its federal tax liability, the taxpayer is prohibited from claiming that deduction for purposes of computing its Massachusetts tax liability. The Commonwealth defines “net income” as “gross income less the deductions, but not credits, allowable under the provisions of the Federal Internal Revenue Code.” In issuing the directive, the Department interpreted “net income” as being computed based on the exact deductions claimed for federal income tax purposes on a federal consolidated return, even if different deductions could have been elected on a separate company federal return. Directive 14-4: Massachusetts Income Tax and Corporate Excise Deductions Where Federal Law Allows A Credit In Lieu of Deduction (December 16, 2014). D. Hot Issues for 2015 Market sourcing and throwout are here: Market sourcing and throwout go into effect for tax years beginning on or after January 1, 2014. As discussed above, the Department’s proposed rules are lengthy and complex and contain several traps for the unwary. Some areas of potential concern are the Department’s attempt to prevent taxpayers who use a “reasonable approximation” method from later filing amended returns; the disparate treatment of sales of intangible property compared to licenses; the exclusion of receipts from sales of partnership interests from the sales factor; and the increasing potential for distortion created by various throwout rules. Because the Department’s final regulations generally prohibit taxpayers form adjusting their reasonable approximation method, taxpayers must take extreme care when calculating their receipts factor on the first return filed using market sourcing rules. Receipts from providing professional services are treated differently under market sourcing: One interesting aspect of the final market sourcing regulations is that the Department has determined that, unlike all other service receipts, receipts from sales of professional services must be sourced in the first instance using rules of reasonable approximation. The Department’s position appears to be contrary to the statute, which requires taxpayers to first source sales of services to the location of delivery. Rules of reasonable approximation are only supposed to apply if the location of delivery cannot be determined.7 Denying taxpayers the ability to source receipts based on the location of delivery can dramatically alter the sourcing of some receipts. Take brokerage services, for example. Under the current regulations, brokerage services are treated as a professional service and brokerage fees are sourced to the purchaser location under rules of reasonable approximation. Assuming an individual customer is located in Massachusetts, the brokerage fees are 100% sourced to Massachusetts.8 The result is vastly different if receipts form brokerage services are sourced based on delivery location, using the plain language of the statute. Brokerage services would appear to be analogous to services delivered “on behalf” of a customer.9 To determine the “delivery” location of services delivered on behalf of a customer, the regulations ignore customer location. Instead, delivery occurs at the location where the taxpayer actually delivers the service. For example, if a New York broadcaster sells advertising placement to be shown only in the New York City market to a Massachusetts customer, the broadcaster ignores the 7 M.G.L. c. 63, § 38(f). See 830 CMR 63.38.1(9)(d) 4.d (Example 1 and 2). 9 See 830 CMR 63.38.1(9)(d) 4.c. 8 10 fact the customer is located in Massachusetts the service is deemed to be delivered in New York City, where the advertisement is broadcast to an audience “on behalf” of the customer.10 In the same way, a broker that executes a trade on an exchange located in New York delivers its service “on behalf” of its Massachusetts customer at the location of the exchange and should be able to source the sale to New York—not Massachusetts. Thus, under a “location of delivery” rule, the sourcing of brokerage fees could produce a completely different result than that produced under the regulation. The Department’s determination regarding professional services appears to be contrary to the intent of the Legislature to source receipts to delivery location and some taxpayers providing professional services will have a strong argument that they should be entitled to source their receipts using a method other than that outlined in the regulations. The Department continues to challenge deductions for payments to affiliated entities: The Department continues to aggressively challenge intercompany payments between affiliated entities at audit—especially in audits involving tax years before mandatory combined filing went into effect. In pending or recently resolved cases, the Department has been arguing for: The reclassification of payments made by a distribution company for purchases of products from its affiliate as embedded royalties; The disallowance of deductions for amounts paid to affiliates for various services; The increase of a taxpayer’s net income derived from sales of pharmaceuticals to an affiliated retailer, based on general industry financial ratios; and The increase of a taxpayer’s net income derived from sales to affiliates despite two third-party transfer-pricing studies supporting taxpayer’s sales price. A recent filing with the ATB by a national restaurant chain is illustrative. The chain had a centralized purchasing and distribution entity that handled just-in-time purchasing for food, as well as centralized purchasing for other products used at the chain’s restaurant locations around the country. Separate legal entities operated the chain’s restaurant locations. These entities purchased food and other products from the purchasing and distribution company. The auditor first asserted that the purchase price charged by the purchasing and distribution company was greater than an arm’s-length price and, thus, limited the deductions claimed by the restaurant entities for the cost of their purchases, pursuant to the Department’s authority under M.G.L. c. 63 § 39A. The auditor then made a second adjustment, further reducing the cost-of-goods-sold deduction for the restaurant entities, by treating a portion of the already reduced purchase price paid as an “embedded royalty” that was not deductible under intangible expense add-back provision. The Department appears to be making transfer pricing adjustments on a case-by-case basis. As cases proceed through the appeal process, the Department will likely be required to develop standards to justify its adjustments. Taxpayers should keep a close eye on briefs and other Department filings in which the Department sets forth standards for determining fair intercompany pricing. Cost of performance litigation continues: While market sourcing is in effect for tax years beginning on or after January 1, 2014, the application of the cost of performance sourcing rules for earlier tax years continues to be a major source of controversy at the ATB. Dozens of recently settled or pending appeals involve situations in which either the taxpayer or the Department is arguing for “all or nothing” cost-of-performance sourcing of certain receipts. Examples of the types of receipts for which the Department has objected to sourcing entirely outside Massachusetts based on using an “operational approach” include: 10 Franchise fees; Broker/dealer receipts (several cases); See 830 CMR 63.38.1(9)(d) 4.c.ii(C)1. 11 II. Consulting fees; Receipts from cable television programming services; Money transfer charges; and Wholesaler credits. Sales and Use Tax A. Judicial Developments Massachusetts’ use tax policy on vehicles purchased out-of-state upheld by ATB in Regency Transportation: On December 4, 2014, the ATB issued Findings of Fact and Report in which the ATB held that a taxpayer, an interstate freight transportation company, was subject to Massachusetts use tax on vehicles purchased outside of Massachusetts, because those vehicles were stored and used in Massachusetts. The vehicles in question had all been purchased in states that either did not impose a sales tax or did not impose a sales tax on vehicles engaged in interstate commerce. The taxpayer had argued that the vehicles were exempt from tax because they were engaged in interstate commerce (the taxpayer’s transportation business covered the entire Eastern United States), and that the imposition of the tax on the taxpayer failed to satisfy all four prongs of the test set forth by the United States Supreme Court in Complete Auto Transit, Inc. v. Brady.11 The taxpayer argued that the tax must be apportioned among all states in which the vehicles were used, because subjecting the entire purchase price of the vehicles to Massachusetts use tax resulted in the vehicles being taxed twice. The ATB rejected that argument, holding that the use tax need not be apportioned because the Massachusetts use tax scheme prevented double taxation by allowing a credit against the use tax for sales tax paid to other states. On the issue of penalties, the ATB ruled in the taxpayer’s favor. It held that the penalties assessed against the taxpayer should be waived because the taxpayer had relied on a letter ruling12 issued by the Department in 1980, which provided an exemption from use tax for certain purchases of vehicles bought outside of Massachusetts that entered the Commonwealth for the first time while engaged in interstate commerce. The ATB noted that the letter ruling was based on regulations that ceased to be in effect in 1996, but held that the taxpayer’s reliance on the ruling was reasonable in light of the fact that the Department had continued to publish the outdated ruling. However, this reliance was not sufficient to defeat the Department’s assessment of tax. The taxpayer has appealed the ATB’s decision to the Appeals Court. The taxpayer’s brief is due April 28, 2015. Regency Transportation, Inc. v. Commissioner, ATB Docket No. C310361 (Mass App. Tx. Bd. December 4, 2014) appeal pending, Mass App. Ct. Docket No. 2015-P0384. ATB finds orthopedic braces are exempt from sales and use tax: On October 24, 2014, the ATB issued Findings of Fact and Report holding that orthopedic braces were exempt from sales and use tax. The ATB concluded that the braces were “individually designed, constructed or altered” to be used as a brace for a “particular crippled person” within the meaning of G.L. c. 64H, § 6(l). The ATB ruled for the taxpayer, finding that each brace had a unique function and was individually fitted to each patient by a certified orthotics fitter. The fit was made by following a detailed set of instructions written by the prescribing physician, which set forth the type of brace required, the desired range of motion, the patient’s injury history, and the patient’s physical attributes. Accordingly, the ATB found the braces indistinguishable from 11 12 430 U.S. 274 (1977). Letter Ruling 80-22, May 9, 1980. 12 the orthopedic foot braces the Commissioner ruled were exempt in Letter Ruling 98-8. Excel Orthopedic Specialists, Inc. v. Commissioner, ATB Docket No. C318083 (Mass App. Tx. Bd. October 24, 2014). B. Administrative Developments The Department rules that a lump sum contract to fabricate, engineer and install a ski lift is a construction contract: The Department issued a letter ruling concluding that a contract to fabricate, engineer, and install a ski lift, in exchange for a lump sum contract price, was a construction contract. The contractor agreed to furnish the component pieces of the ski lift (which it purchased from an affiliate who manufactured thet parts); and also to provide labor, supplies, and materials to install the ski lift; concrete foundations for towers and terminals; and cables, batteries, motors, terminals, etc. In a construction contract, the contractor bears the responsibility to pay sales and use tax on its taxable purchases used or consumed in performing the contract—the contractor’s customer does not pay sales and use tax on the price of the construction contract. A construction contract is “a contract for the construction, reconstruction, alteration, improvement remodeling or repair of real property.”13 However, a contract will not be a construction contract if the contract is a sale in which contractors act as a retailer selling tangible personal property in the same way as other retailers, and simply install a complete unit of standard equipment which requires no further fabrication beyond the installation, assembly, or connection services. Here, the Department ruled that the contract involved more than installation of a complete unit of standard equipment, notwithstanding some of the component pieces of the ski lift were standard equipment, and a provision in the contract which specified that the ski lift remained personal property until the final installment payment was made on the lump sum contract. Once the final payment was made, the contract deemed the ski lift real property. Thus, the Department ruled that the contract qualified as a construction contract, and the contractor, not the customer, was responsible for paying the tax on its purchases used or consumed in performing the contract. Letter Ruling 15-1: Sales/Use Tax on Sale and Installation of a Ski Lift (January 20, 2015). The Department revises its position on cloud computing services: The Department revised and reissued Letter Ruling No. 12-8 regarding the taxability of a vendor’s cloud computing services, finding that the services are not subject to sales tax. In Letter Ruling 12-8, the vendor sold cloud computing products that gave customers access to the vendor’s computer infrastructure and operating system, allowing the customer to use the vendor’s computer resources and storage space to perform various activities. Customers needed an operating system that would enable them to use the vendor’s cloud computing products. They had three options: (1) provide their own operating system; (2) use an open-source system; or (3) use an operating system the vendor licenses from a third party. The vendor charged its customers by the hour, and imposed a higher hourly rate for customers that used a third-party operating system. In the original version of the ruling, the Department found that charges associated with the third option were subject to tax, because the customer’s object in choosing that option was to obtain the right to use software—not the vendor’s cloud computing services. (The Department previously found that when customers chose the other two options, the vendor’s charges were not subject to tax.) In its revision, the Department reversed course, finding that the vendor’s services were not subject to tax, regardless of the operating system option selected by the customer. 13 Classic Kitchens, Inc. v. Commissioner, ATB Docket No. C262393 (Mass App. Tx. Bd. March 15, 2004). 13 The Department, however, also commented that the vendor would be required to pay Massachusetts use tax on the “apportioned cost of prewritten operating system software that it consumes in the provision of the nontaxable services to customers in Massachusetts.” This appears to be an expansion of the Department’s policy regarding the taxability of remotely accessed software. The Department also ruled that the vendor’s remote storage services were not subject to tax. Letter Ruling 12-8: Cloud Computing (July 16, 2012, revised November 8, 2013). The Department rules that sales of online database access are not taxable: On February 10, 2014, the Department released Letter Ruling 14-1, responding to a taxpayer’s inquiry into whether its sales of subscriptions to its online database were taxable sales of prewritten software, or nontaxable sales of web database services. The taxpayer sold its customers subscriptions to a database that provided information on suppliers and purchasers of goods and services located throughout the world. Using the taxpayer’s website, customers could view the database to find suppliers and purchasers best suited to meet their needs. The taxpayer relied heavily on the use of software to compile the data and organize it in a way that was user-friendly; however, no software was transferred to or downloaded by the customer. In addition to accessing the database, customers could create profiles viewable by other customers; upload information about their business; receive reports provided by the taxpayer’s analysts; and send emails to purchasers or suppliers through the taxpayer’s website. The Department concluded that the taxpayer’s subscription sales were not taxable. Applying the object of the transaction test, the Department determined that the customers sought access to the taxpayer’s database, not the software facilitating its use. Accordingly, the Department found that the taxpayer’s activities were the sale of “database services,” not subject to Massachusetts sales tax. Letter Ruling 14-1: Sales/Use Tax on Subscription to Online Merchandise Database (February 10, 2014). Training services provided online are not subject to sales and use tax: On May 29, the Department issued Letter Ruling 14-4, ruling that corporate training programs accessed online were not subject to sales and use tax. The Taxpayer sold training programs focused on corporate ethics and compliance. The programs were available only online, and were hosted on a third-party server. The training programs had both audio and visual components, as well as interactive features: users could take quizzes and answer questions. Purchasers were able to access the training programs through use of an ID number and password provided by the Taxpayer. The purchasers had no ability to direct or control the training programs’ underlying software. The Taxpayer inquired whether the sales of its online training programs were subject to sales and use tax. The Department ruled that the Taxpayer’s sales were not subject to tax, relying on the “object of the transaction” test. The Department determined that the object of the transaction was the information contained in the online training programs, rather than the software used to communicate that information to the user. Accordingly, the Department concluded that the Taxpayer sold nontaxable database access services, rather than taxable prewritten software. Letter Ruling 14-4: On-Line compliance and Ethics Training (May 29, 2014). Draft Directive pending to provide guidance on the “object of the transaction” test for mixed software and services products: After issuing over a dozen letter rulings on the application of sales tax to a variety of transactions involving the purchase of software and services, the Department issued a draft directive attempting to summarize the analysis and rules scattered throughout its ad hoc guidance to taxpayers. Although there hasn’t been any visible movement toward finalizing the Directive, the Department has indicated it still intends to do so. 14 As outlined in the Draft Directive, when nontaxable services and access to prewritten software are sold for a single bundled price, Massachusetts looks to the object of the transaction to determine whether the transaction is a taxable sale of prewritten software, or a nontaxable service. The Draft Directive lays out eight criteria that may indicate that the object of a transaction is the purchase of taxable software—including the vendor branding itself as a provider of ASP, software as a service (“SaaS”), or cloud-computing services—and ten criteria that may indicate that the object of a transaction was the purchase of a nontaxable service. In general, under the Draft Directive, a bundled transaction is more likely to be treated as a taxable purchase of software: The more the purchaser is able to manipulate or control the software; and The fewer services the vendor provides to the purchaser beyond and repairing the software and the network maintaining The Draft Directive is subject to change before the Department issues its final guidance. The timeline for issuing the final Directive is unclear. Working Draft Directive 13-XX: Criteria for Determining Whether a Transaction is a Taxable Sale of Pre-Written Software or a Nontaxable Service (February 7, 2013). Directive issued to provide guidance on sales tax exemption for certain direct mail promotional advertising materials: Sales of direct promotional advertising materials distributed to residents of the Commonwealth are exempt from sales and use tax. M.G.L. c. 64H, § 6(ff). The Department issued a Draft Directive to provide guidance on the exemption. The Draft Directive provides that materials are exempt if they meet the following criteria: The materials contain discount coupons; The materials are no longer than six pages; The materials qualify as direct mail; The materials are distributed by U.S. mail or common carrier; The materials are distributed at no charge to the mailing recipient; and The materials are not be mixed-use publications. The Draft Directive defines “direct mail” as material mailed directly to a specific or prospective customer that is listed in the sender’s mailing lists or database. “Coupon” is defined in the Draft Directive as a printed piece of paper, scan card, code, or other identifier that, upon presentation to a vendor, entitles a retail customer to receive a service or product for free or at a lower price. Directive 14-3: Sales and Use Tax Exemption for Certain Direct Mail Promotional Advertising Materials under G.L. c. 64H, s. 6(ff) (October 20, 2014). C. Hot Issues for 2015 Mobile telecommunications company challenges sales tax assessment on early termination fees: In a petition filed recently with the ATB, a mobile telecommunications company is contesting a sales tax assessment by the Department. The assessment resulted from the Department asserting that the sales tax on telecommunications services applies to “early termination fees.” For sales tax purposes, taxable telecommunications services are defined as the “transmission of messages or information by electronic or similar means.” At audit, the Department adopted an expansive view of this definition, and issued an assessment against the Petitioner for failure to collect sales tax on “early termination fees” that the Petitioner charged when a customer with a contract cancelled the contract prior to its expiration date. Moreover, the Department’s assessment—according to the Petitioner—included tax on early termination fees that were waived and thus never collected from customers. 15 In its ATB petition, the telecommunication company is arguing that the early termination fees received were not charges for the transmission of messages and information. Indeed, the fees in question were charged because the customer informed the vendor that it did not want the vendor to “transmit” any messages. Are eFax emails taxable telecommunications services?: Separate from the taxpayer challenge to the Department’s assessment of early termination fees, a recent ATB petition alleges that, on audit, the Department has taken an aggressive position that the scope of taxable telecommunications services includes “eFax” services. The appeal involves a vendor that receives faxes intended for its customers. The vendor converts each fax into a computer file and sends an email to the intended recipient of the fax with a copy of the file. The intended recipient can then view the file wherever they can access their email. In its petition to the ATB, the vendor alleges that the Department auditor classified these eFax services as taxable telecommunications services and estimated the portion of the services to be sourced to Massachusetts based on the percentage of population in Massachusetts to the population through the United States as a whole. The taxpayer is challenging the assessment on a variety of grounds, including (1) whether the eFax services provided by the vendor are non-taxable data processing or information services; (2) whether the assessment of sales tax on the eFax services violates the Internet Tax Freedom Act; and (3) whether the assessment is contrary to the Department’s own published guidance. This appeal is relevant to any company doing business in Massachusetts that provides any service whereby an electronic communication—fax, voicemail, video, etc.—is converted to a file format that the customer can access by email. Software services are still being taxed: The “object of the transaction” test outlined in the Department’s Draft Directive (see II.B.5.) tilts heavily in the favor of taxing purchases that combine both software and services on the basis that the object of the customer’s purchase was taxable software. For example, the directive indicates that merely branding a sale as a SaaS transaction—while not determinative of the tax treatment—is an indication that the object of the purchase is software, not related services. Several taxpayers have brought appeals to the ATB challenging the Department’s application of the “object of the transaction” test. Currently, there are pending appeals filed by both SaaS and ASP vendors contending that their sales are not subject to sales tax in Massachusetts. Can Massachusetts tax remotely accessed software? In addition to appeals challenging the Department’s application of the “object of the transaction” test, there are also pending appeals at the ATB that raise the issue of whether Massachusetts can tax remotely accessed software at all. Vendors that provide their customers with a free applet in order to allow the customers to access software hosted by the vendor on a server outside of Massachusetts via the internet, and vendors whose customers access the vendors’ software exclusively through web browser are challenging the Department’s regulation treating such sales as subject to sales tax to the extent the purchaser accesses the software in Massachusetts. The vendors are arguing that there is no taxable “transfer” of software and therefore, the sales are not subject to Massachusetts sales tax. If these cases are ultimately decided in the vendors’ favor, almost a decade of Department guidance would be overturned and numerous vendors would be entitled to abatements. III. Tax Administration A. Non-filer Amnesty Proposed: As part of his budget proposal for fiscal year 2016, Governor Charlie Baker, who took office in January, announced his intention to enact legislation authorizing a tax amnesty program for nonfilers to run throughout the entire 2016 fiscal year (July 1, 2015 through June 30, 2017). Businesses and individuals with Massachusetts tax liabilities that have not previously filed Massachusetts returns, regardless of whether they are known or unknown to the 16 Commonwealth, would be eligible to participate, as long as they have not yet received an assessment. IV. B. Mark Nunnelly takes over as Commissioner of Revenue: On March 26, 2015, Governor Charlie Baker appointed Mark Nunnelly as the new Commissioner of Revenue, effective March 30, 2015. Nunnelly replaced former Commissioner Amy Pitter, who announced on January 6, 2015, that she would be resigning as Commissioner. C. Department is currently offering a tax amnesty program: The Legislature authorized a tax amnesty program, permitting taxpayers to pay delinquent taxes, including corporate excise tax, without incurring penalties. See above, I.C.2., for more details about the program. Biographies A. Michael A. Jacobs Mike is a partner in Reed Smith’s State Tax Group. He focuses his practice on state tax planning and controversy matters, specializing in income/franchise and sales and use taxes. Prior to joining Reed Smith, Mike was a partner at the Boston based law firm of Choate, Hall & Stewart. He is admitted in Massachusetts and has over 15 years of experience handling Massachusetts state tax matters. Mike writes and speaks frequently on Massachusetts tax issues, including the following: Massachusetts Quarterly Update Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 6 March 2015 Reed Smith Massachusetts Corporate Tax Teleseminar: Massachusetts Releases Final Market Sourcing and Throwout Regulations "Over Seventy Pages; What Do You Need to Know?" Co-Presenters: Robert E. Weyman, Brent K. Beissel 21 January 2015 AIM Proposes Improvements to Tax Rules Co-Author(s): Robert E. Weyman, AIMBlog 19 December 2014 Massachusetts Quarterly Update Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 14 October 2014 Reed Smith Massachusetts Corporate Tax Teleseminar: Massachusetts Releases Proposed Market Sourcing and Throwout Regulations, What Does it Mean for You? Co-Presenters: Robert E. Weyman, Brent K. Beissel 10 April 2014 Massachusetts Quarterly Update Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 11 February 2014 Massachusetts Quarterly Update Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 16 October 2013 Massachusetts Delays Reporting for Software Services Tax; Repeal Imminent? 17 Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 16 September 2013 Massachusetts Rules Against Taxpayer on Treatment of Intercompany Debt—Again Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 6 September 2013 Reed Smith Massachusetts Corporate Tax Teleseminar Co-Presenter: Robert E. Weyman 21 August 2013 Reed Smith Massachusetts Sales Tax Teleseminar Co-Presenter: Robert E. Weyman 7 August 2013 Massachusetts Quarterly Update Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 16 July 2013 Massachusetts Department of Revenue and Appellate Tax Board Look to Expand Tax Dispute Mediation Programs Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 21 June 2013 Massachusetts Tax Developments Co-Author(s): Robert E. Weyman, Brent K. Beissel Reed Smith Client Alert 25 April 2013 Software Vendor Challenges Massachusetts’ Restrictive Policy on Multiple Points of Use Certificates Co-Author(s): Robert E. Weyman Reed Smith Client Alert 12 April 2013 Reed Smith Massachusetts Quarterly Update Co-Author(s): Robert E. Weyman Reed Smith Client Alert 4th Quarter 2012 Title Transfer Not Enough to Establish Resale in Massachusetts Co-Author(s): Robert E. Weyman Reed Smith Client Alerts 13 November 2009 Massachusetts Appellate Tax Board Expands Availability of Sales Tax Exemption for R&D Corporations—But Constitutional Issues Still Remain Unresolved Reed Smith Client Alerts 8 September 2007 B. Robert E. Weyman Rob is an associate in Reed Smith’s State Tax Group. He focuses his practice on state tax planning and controversy matters, specializing in income/franchise and sales and use taxes. Rob writes and 18 speaks frequently on Massachusetts tax issues and has worked on several significant Massachusetts tax appeals. C. Brent K. Beissel Brent is an associate in Reed Smith’s State Tax Group. He focuses his practice on state tax planning and controversy matters, specializing in income/franchise and sales and use taxes. Brent writes frequently on Massachusetts tax issues and has worked on several significant Massachusetts tax appeals. Brent also edits and contributes to Reed Smith’s Massachusetts tax blog: www.massachusettssalt.com. 19 MASSACHUSETTS STATE DEVELOPMENTS Kathleen King Parker Pierce Atwood LLP 100 Summer Street, Suite 2250 Boston, MA 02110-2106 617-488-8114 voice 617-824-2020 fax Email: [email protected] Web: www.pierceatwood.com I. Philip S. Olsen Pierce Atwood LLP 100 Summer Street, Suite 2250 Boston, MA 02110-2106 617-488-8113 voice 617-824-2020 fax Email: [email protected] Web: www.pierceatwood.com INCOME/FRANCHISE TAXES A. Legislative Developments Increase in EDIP Tax Credits. This legislation increases the annual cap for the economic development incentive program (EDIP) tax credits from $25 million to $30 million. It also reduces the amount of life sciences tax incentives that would have been available for the 2015 tax year from $30 million to $25 million. St. 2014, c. 360. Amnesty Program. Beginning March 16, 2015, the Massachusetts Department of Revenue (the “DOR”) is offering an aptly described “limited” amnesty program for taxpayers with certain tax liabilities. The 60-day program applies to all corporate excise taxes imposed under G.L. c. 63 (corporate excise, financial institutions, insurance, public utilities, and banks), estate taxes imposed under G.L. c. 65C, fiduciary income taxes imposed under G.L. c. 62, and individual use tax on motor vehicles imposed under G.L. c. 64I. All penalties are covered including the onerous 20 percent penalty imposed by G.L. c. 62C, § 35A for substantial understatement of tax. The Amnesty Program will apply to tax years or periods where a Notice of Assessment was issued by the Commissioner of Revenue on or before January 1, 2015. The program is limited by certain conditions that may exclude or deter otherwise interested taxpayers, including: The Commissioner of Revenue must notify taxpayers of their eligibility to participate in the Amnesty Program. Only those taxpayers to whom a Tax Amnesty Notice has been issued may be eligible. The taxpayer may not contest the tax at issue. In order to participate in the Amnesty Program, the taxpayer cannot seek a refund or contest the liability of the tax amounts paid pursuant to amnesty. Corporate taxpayers, to be eligible, must also be in compliance with all filing requirements with the Massachusetts Secretary of State. St. 2015, c. 52. B. Judicial Developments Biotechnology Manufacturer Has Massachusetts Nexus. The Massachusetts Appellate Tax Board (the “ATB”) held that Genentech, Inc., an out-of-state biotechnology company, was engaged in manufacturing and its manufacturing activities in Massachusetts were sufficient to create nexus in Massachusetts. Manufacturing companies are required to use a single sales factor apportionment formula, whereas most other corporations are required to use a three-factor apportionment formula. Genentech argued it was not a manufacturing company and thus was allowed to use the three-factor formula. The ATB found that Genentech retained title to bulk inventory during a stage of production in Massachusetts and to drugs used during clinical trials conducted in Massachusetts. Furthermore, Genentech’s Massachusetts manufacturing activity was substantial for the periods at issue since its revenue generated from that manufacturing activity was substantial when measured against its gross receipts, thus it was required to use a single sales factor apportionment formula. Genentech, Inc. v. Commissioner of Revenue, Mass. App. Tax Bd., Dkt. No. C282905 (Nov 17, 2014). {W4803715.3} Financial Institution’s Property Located in Massachusetts for Apportionment Purposes. The First Marblehead Corporation (FMC) helped college students obtain financial assistance for the cost of their education, but did not make any loans directly to the students. Instead, it brought together banks, loan guarantors and loan servicing companies. Third-party banks entered into agreements with FMC through which the banks issued loans to student borrowers. The banks sold portfolios of these loans to a number of different Delaware trusts controlled by Gate Holdings, Inc., a wholly-owned subsidiary of FMC set up largely to hold the beneficial interests of the trusts. Loan servicing was outsourced by FMC to independent entities. Gate had no employees, payroll, tangible assets, or office space. Its principal office was located at the same Boston address as FMC. The ATB held that Gate was a financial institution as defined in G. L. c. 63, § 1, because it derived more than 50 percent of its gross income from “lending activities” in substantial competition with other financial institutions. Since it held loans with students in all 50 states, Gate was entitled to apportion its income in accordance with G. L. c. 63, § 2A. There was no dispute over the calculation of Gate’s receipts or payroll factors. The sole issue on appeal was the calculation of Gate’s property factor. The Supreme Judicial Court (SJC) concluded that the loan portfolios that represented all of Gate's property for the tax years at issue should be treated as having been located entirely within Massachusetts. When the property at issue consists of loans, and the taxpayer does not have a regular place of business as was the case with Gate, then G. L. c. 63, § 2A(e) creates a rebuttable presumption that the loans should be assigned to the taxpayer’s commercial domicile. In this case, Gate’s commercial domicile was Massachusetts. The presumption may be rebutted if the taxpayer demonstrates that the “preponderance of substantive contacts regarding the loan” occurred outside the state. Gate argued unsuccessfully that the loans should be assigned to the out-of-state locations of the loan servicers. The SJC noted that the examination of substantive contacts must consider activities such as “solicitation,” “investigation,” “negotiation,” “approval,” and “administration” of the loan. The only possible factor that could apply to Gate was administration of the loan since it had no role in any of the other listed activities. The First Marblehead Corp. v. Commissioner of Revenue, 470 Mass. 497 (2015). C. Administrative Developments Market-Based Sourcing Regulation Adopted. After several proposed drafts, the DOR repealed and replaced 830 CMR § 63.38.1, which provides the rules for apportioning income from sales other than sales of tangible personal property, to be consistent with recent amendments to G. L. c. 63 § 38. Prior to the statutory change, Massachusetts apportioned these receipts under a “cost of performance” method. Beginning January 1, 2014 (the effective date of the statutory change), all corporations must use market-based sourcing principles in determining the sales factor. The regulation provides specific market-based sourcing rules for the sale, rental, lease or license of real property, the rental, lease or license of tangible personal property, the sale of a service, the license or lease of intangible property, and the sale of intangible property. The regulation includes numerous examples illustrating the sourcing of each category of sale. Sales factor rules for airlines, motor carriers, and courier and package delivery services are now part of this regulation. 830 CMR § 63.38.1. No Ability to Take State Deduction when Federal Credit is claimed in lieu of Federal Deduction. The DOR has stated that in calculating corporate excise tax, Massachusetts law generally permits a taxpayer to deduct a business expense only when that expense is actually deducted for federal purposes. Thus, absent specific statutory authority, when a taxpayer claims a federal credit with respect to an expense, rather than a federal deduction, the taxpayer may not take a deduction at the state level. Massachusetts DOR Directive 14-4 (Dec. 16, 2014). D. Trends/Outlook for 2015 Governor Baker Proposes Tax Legislation. Massachusetts Governor Charlie Baker submitted the Fiscal Year 2016 budget proposal and a stand-alone tax bill. The budget would further delay the taking of the FAS 109 deduction allowed to certain publicly traded companies. Also proposed is a tax amnesty program for non-filers for any tax type and for any tax periods to be made available for a duration of 60 days within fiscal year 2016 but to expire not later than June 30, 2016. Governor Baker hopes the program will generate $100 million of tax revenue. The Governor has also proposed an increase of the earned income tax credit which would be offset by a phase out of the Film Tax Credit. II. TRANSACTIONAL TAXES {W4803715.3} A. Legislative Developments Sales and Use Tax Exemption for Materials Used in Marine Industrial Parks. This new law exempts from sales and use tax sales of building materials and supplies used in the construction, reconstruction, alteration, remodeling or repair of any building or structure located in a marine industrial park that is exclusively used for agricultural production or seafood processing or as a seafood storage facility. St. 2015, c. 503. B. Judicial Developments Interstate Trucks Subject to Use Tax. The ATB held ruled that an interstate carrier was liable for use tax on the full sales price of its fleet vehicles used in interstate commerce, which were purchased out of state but stored and used in the state. The taxpayer purchased tractors and trailers outside of Massachusetts and paid no sales or use tax to any state during the period, therefore the out-of-state transfers exemption provided under 830 CMR 64H.25.1(7)(g) did not apply. The ATB held that the tax was permissible under the Commerce Clause and was administered in a manner consistent with the Equal Protection Clause of the U.S. and Massachusetts Constitutions. The ATB did abate the penalties because the carrier had reasonable cause for failing to file use tax returns or pay use taxes, specifically because the taxpayer had relied on Letter Ruling 80-22, a public written statement by the Commissioner based on regulations which were repealed in 1996, but which nevertheless continued to be published by the Commissioner. Regency Transportation v. Commissioner of Revenue, Mass. App. Tax. Bd., Dkt. No. C310361 (Dec. 4, 2014). Excise Tax Does Not Discriminate Against Satellite Television Companies. In 2010, Massachusetts enacted an excise tax upon satellite companies at a rate of five percent of their gross revenues derived from the provision of video programming in Massachusetts. (See G. L. c. 64M, §§ 1, 2.) DirecTV and Dish Network brought a complaint for declaratory and injunctive relief alleging that the tax violated the Commerce Clause of the U.S. Constitution. They argued that the tax discriminated against interstate commerce because it did not apply to companies that provide video programming through cable networks. The lower court ruled against the satellite companies, and the SJC affirmed. The SJC noted that cable and satellite companies offer similar programming and that there was a great deal of overlap in their methods of operation. However, the companies differ significantly in how they assemble and deliver programming to their customers. Cable companies pay franchise fees to local governments at the rate of three to five percent of gross revenues from cable services. At the same time the excise was enacted against the satellite companies, cable companies became subject to personal property tax on their poles, underground conduits, wires, and pipes. The SJC rejected the argument that the excise tax discriminates against interstate commerce by disadvantaging the satellite companies and benefiting the cable companies. Each is subject to unique obligations in connection with the privilege of selling video programming services to Massachusetts consumers. No greater tax burden was imposed on the satellite companies. In fact, the statute offers a streamlined collection method to the satellite companies because the tax is administered and collected by the DOR. Cable companies, on the other hand, must pay varying amounts to each of the local cities and towns in which they operate. In the eyes of the court, “this instance of differential treatment, rather than burdening the satellite companies, is advantageous to them.” Similarly, the calculation of taxes does not operate to burden the satellite companies. While the satellite companies were subject only to a flat tax rate of five percent of gross revenues, cable companies were obligated, among other things, to pay franchise fees as well as additional fees used to support public-oriented programming. Directv, LLC v. Department of Revenue, 470 Mass. 647 (2015). III. C. Administrative Developments D. Trends/Outlook for 2015 PROPERTY TAXES A. {W4803715.3} Legislative Developments B. Judicial Developments Agricultural Nonprofit is Exempt from Property Tax. The Massachusetts Appeals Court reversed the ATB and held that a Massachusetts not-for-profit corporation is a charitable organization exempt from property taxes. The ATB had held that the taxpayer was not charitable because its primary beneficiaries were its members, which are local farmers. The Appeals Court disagreed and held that the primary beneficiaries were an indefinite number of people, many of whom are not members, and any benefit to member-farmers is but the means adopted for this purpose. The taxpayer distributes a free annual locally grown farm products guide to nearly 50,000 households, and help the elderly, low income citizens, school children, and urban residents receive fresh local food that they would otherwise struggle to access. By increasing food security and developing sustainable local farming, the taxpayer engages in charitable activities that benefit the general public. Community Involved in Sustaining Agriculture, Inc. v. Board of Assessors of Deerfield, Mass. App. Ct., Dkt. No. 13-P-1050 (Rule 1:28 Order) (Nov. 10, 2014). IV. C. Administrative Developments D. Trends/Outlook for 2015 GENERAL A. Legislative Developments B. Judicial Developments C. Administrative Developments New DOR Commissioner Appointed. On March 26, 2015, Mark Nunnelly was announced as the next Commissioner for the Massachusetts DOR, effective March 30, 2015. Mr. Nunnelly, a former Managing Director of Bain Capital, will replace current Commissioner Amy Pitter. Unified Audit Procedures for Pass-Through Entities. The DOR promulgated a new regulation to implement the unified audit procedures for pass-through entities as authorized by G. L. c. 62C § 24A. The regulation streamlines audit, assessment, and appeal procedures as they apply to pass-through entities and their members, and ensures consistent tax treatment of the members of a pass-through entity. The unified audit procedures provide for a separate audit process applicable only to pass-through entities that is conducted at the entity level. The entity is represented by the tax matters partner, who has an obligation to keep the members of the entity informed as to the audit. 830 CMR 62C.24A.1 Amendment to Tax Information Exchange Regulation. The DOR amended 830 CMR § 62C.22.1, related to exchange of information with other taxing authorities, clarifying that it applies to disclosures related to specific requests from other taxing authorities and does not affect the ability of the Commissioner to enter into and share information on an ongoing basis pursuant to agreements with other taxing authorities. D. V. Trends/Outlook for 2015 PROVIDERS’ BIOGRAPHIES Kathleen King Parker, partner, is a member of the Pierce Atwood State & Local Tax Group. Ms. Parker’s practice concentrates on state tax matters and state tax litigation. She also has significant experience in federal and local tax matters, including multi-state tax planning. Before joining the Boston office of Pierce Atwood, Ms. Parker practiced at Choate Hall & Stewart in Boston and served in state government as an Assistant Attorney General, Assistant District Attorney, and Chief of the Rulings and Regulations Bureau of the Massachusetts Department of Revenue. Ms. Parker is past Chair of the National Association of State Bar Tax Sections, past Chair of the Tax Section of the Boston Bar Association and past Chair of its State Tax Committee. Ms. Parker is active in the State and Local Tax Committee of the Taxation Section of the American Bar Association, author of the Massachusetts Chapter {W4803715.3} of the ABA Sales & Use Tax Desk Book, and past editor of The State and Local Tax Lawyer. In addition, she is a Trustee of the Massachusetts Taxpayers Foundation. She speaks and writes frequently on tax law and related subjects. Philip Olsen focuses his practice on local and state tax consulting and litigation. Philip has more than 20 years of experience representing clients in major tax controversies before administrative boards, superior courts, bankruptcy court, state appeals courts, and state supreme courts. He also has experience in unclaimed property consulting and audit defense. Prior to joining Pierce Atwood Philip was a partner at Burns & Levinson LLP, and before that, a partner with McCarter English. He was also a senior trial attorney and litigation supervisor for the Department of Revenue, where he litigated significant tax cases on behalf of Massachusetts before the Appellate Tax Board, the Superior Court, and the U.S. Bankruptcy Court. {W4803715.3} NEW HAMPSHIRE STATE DEVELOPMENTS WILLIAM F. J. ARDINGER CHRISTOPHER J. SULLIVAN KATHRYN H. MICHAELIS STANLEY R. ARNOLD Rath, Young and Pignatelli, P.C. One Capital Plaza Concord, NH 03301 Phone: 603.226.2600 E-Mail: [email protected] Web Site: www.rathlaw.com I. INCOME/FRANCHISE TAXES A. Legislative Developments 1. Reporting Federal Changes. On June 20, 2013, Governor Hassan signed into law S.B. 30, amending a taxpayer’s requirement to report changes made to its tax return by the Internal Revenue Service to the New Hampshire Department of Revenue Administration (the “DRA”). The law now requires DRA to notify a taxpayer that DRA is reviewing the taxpayer’s return within 6 months of the taxpayer’s report to DRA of a federal change. The law previously required the Department to notify the taxpayer of any adjustment to the tax due within 6 months. The new law will apparently broaden the time the Department has to issue an assessment, although the Department asserts that the new law does not change its practices with respect to issuing RAR adjustments. TAXPAYERS ARE ADVISED TO PROCEED WITH CAUTION REGARDING RARs, and to include RAR analysis when engaged in settlement discussions. 2. Definition of Compensation. For taxable periods beginning on or after January 1, 2013, H.B. 2 (2013) amended the definition of “compensation” for purposes of the Business Enterprise Tax (the “BET”) to mean all wages, salaries, fees, bonuses, commissions, or other payments paid “directly” or accrued “by the business enterprise.” The amendment excludes from compensation “any tips required to be reported by the employee to the employer under section 6053(a) of the United States Internal Revenue Code.” 3. R&D Tax Credit Increased. On March 21, 2013, Governor Hassan signed into law S.B. 1, which increased the maximum credit allowed for qualified manufacturing research and development expenditures under RSA 77-A:5, XIII, (the “R&D Credit”) from $1,000,000 to $2,000,000. This increase to the R&D Credit was originally part of her “Innovate NH” jobs plan and was announced as part of her proposed budget. The bill also repealed the expiration date for the R&D Credit, which was previously extended by H.B. 518 (2012) from July 1, 2013 to July 1, 2015. The DRA issued administrative guidance concerning these changes in TIR 2013-001 (Apr. 17, 2013). In July of 2014, the Governor announced that 166 businesses received tax credits in 2014 as part of the program. 4. Net Operating Loss Increase. The amount of net operating losses that may be carried forward and deducted against BPT in future tax years has increased from $1,000,000 to $10,000,000 effective January 1, 2013. H.B. 2 (2011); H.B. 242 (2012). 5. BET Carry Forwards. On June 29, 2011, H.B. 187, which extended the carry forward period during which a taxpayer may credit the amount of BET paid against BPT liability, became law without the signature of then Governor Lynch. The act, which amended RSA 77-A:5, X, increased the carry forward period from five to ten taxable periods. The change took effect for taxable periods ending on or after July 1, 2014. In 2014, S.B. 243 further amended the provision to clarify that any unused BET credit from taxable periods ending on or after December 31, 2014 may be carried forward for 10 years from the period in which it was paid. 1 6. Tax Expenditures Examined. H.B. 1531 (Ch. 28, Laws 2014) established a Joint Committee on Tax Expenditures Review to review all qualifying tax expenditures on a rotating 5 year basis. See also TIR 2014-005 (9/8/14). B. Judicial Developments No recent judicial developments. II. C. Administrative Developments 1. BET Filing Threshold. RSA 77-E:5, I requires the DRA to biennially adjust the BET filing thresholds for inflation, using the Consumer Price Index. The DRA inflation adjusted BET filing thresholds for taxable periods ending on or after December 31, 2015 are gross business receipts in excess of $207,000 or enterprise value tax base greater than $103,000. TIR 2014-012 (12/8/14). 2. BET Carry Forwards. On September 8, 2014, DRA issued administrative guidance reminding taxpayers and practitioners of the new ten year carryforward provision for any unused BET credit and to keep BET and BPT records necessary to utilize the new carryforward. TIR 2014-005 (9/8/14). 3. Basis Step-Up Adjustment Under BPT. DRA has aggressively taken the position that when a “sale or exchange” of a business organization occurs and results in a net increase in the basis of the business organization’s assets transferred or sold, an additional modification in the amount of the increase must occur pursuant to RSA 77-A:4, XIV of the Business Profits Tax (“BPT”). Recent DRA audits have sought to impose this position in the context of transfers of partnership interests that result in a basis increase under section 743(b) of the Internal Revenue Code, as well as sales of interests in single member limited liability companies. This attempt to apply “aggregate theory” principles from the federal system to the separate entity requirements of the BPT system often violates the BPT statute. 4. Business Profits Tax Rules Revisions. The BPT rules were recently revised and became effective January 16, 2015. Changes include new definitions, new rules regarding taxpayer identification, updating provisions reflecting the legislative changes to the reasonable compensation deduction, changes to the economic revitalization tax credit and other credit carryforwards, return attachment requirements, newly-added QIC election and reporting requirements and informal pre-assessment conference rules. TRANSACTIONAL TAXES New Hampshire does not have a general retail sales tax, but employs a number of transactional taxes, including a meals and rooms tax and a real estate transfer tax. A. Legislative Developments 1. Real Estate Transfer Tax Definitions and Exceptions. If enacted, H.B. 180 (2015) would amend the definition of “price or consideration” for purposes of the Real Estate Transfer Tax (“RETT”), clarifying that the definition only applies in the case of a “contractual transfer.” Additionally, the bill would amend the list of transactions that are exempt from RETT to clarify that, in addition to transfers that occur by devise, transfers by other testamentary disposition would be exempt from RETT, regardless of any consideration paid or obligation assumed by the transferee. The House Ways and Means committee voted in favor of the bill and practitioners expect the House to pass it. The Bill is currently in Senate Ways and Means. Relatedly, S.B. 232 would amend the RETT statute to explicitly exempt the transfer of any lease, where the term of the lease, including all renewals, is less than 99 years. This legislation was proposed in the wake of the 2014 readoption of the DRA’s RETT regulations, discussed below. 2 III. 2. RETT Examples. On July 11, 2014, Governor Maggie Hassan signed S.B. 243 into law, authorizing the DRA to adopt rules containing written examples of transactions that are taxable or nontaxable under the RETT. DRA solicited support for this legislation from the tax professional community, and practitioners testified before the Legislature in support of the bill on the basis that it is necessary to clarify the law following the controversial court decisions in the RETT area over the last five years. B. Judicial Developments 1. Taxation of Online Travel Company Services. On October 16, 2013, the State filed a complaint in Superior Court against multiple online travel companies, including Expedia, Inc., Hotels.com, LP, Hotwire, Inc., Orbitz, LLC, Priceline.com, Inc., and Travelocity.com, LP (the “OTCs”), alleging that the OTCs failed to collect and remit Meals and Rooms Tax (“M&R Tax”). The case remains pending in Superior Court with trial expected in early 2016. C. Administrative Developments 1. Statutory Conversions. The DRA has taken the position that no RETT is due following the conversion of a Massachusetts business trust, whose sole asset is real estate located in New Hampshire, to a New Hampshire limited liability company, pursuant to the statutory conversion provisions of RSA 304-C. Dec. Rul. 10566 (4-8-2014). In the ruling, the current beneficiary of the trust would have an identical interest in the new limited liability company, and would receive no consideration other than the membership interest in the new entity. 2. New RETT Forms. In January of 2014, the DRA modified the RETT forms (the CD-57-P, CD-57-S and PA-34) purportedly to conform to the standardized format of other DRA forms and to allow for digital scanning of the forms. After the release of the 2014 forms, some taxpayers and practitioners continued to file returns using the prior versions of these forms, which the DRA accepted in lieu of the current versions. However, as of January 1, 2015, the DRA no longer accepts returns filed using the old forms. Taxpayers or practitioners must file a current version of the RETT forms no later than 30 days from the date of the transfer or recording of the deed, whichever is later, in order to avoid interest and penalties. TIR 2014-010 (12/1/14). 3. Revisions to RETT Rules. The DRA’s real estate transfer tax regulations (Rev Chapter 800) were up for readoption in 2014. The DRA took the timing of the readoption as an opportunity to clean up old provisions and address numerous issues stemming from several controversial cases addressing the imposition of the tax on related-party transfers. The rules went through several stages of revisions and hearings with JLCAR, with some revisions resulting in controversy, including the disclosure of a policy position to tax certain ground leases. Other areas of taxation were clarified, including reorganizations and conversions, de minimus transfers of real estate holding companies, and updating the definition of a “real estate holding company.” Some of these revisions remain in dispute, prompting further examination during the current legislative session. PROPERTY TAXES A. Legislative Developments 1. Renewable Energy PILOTs. On July 28, 2014, Governor Maggie Hassan signed H.B. 1549 into law, which makes explicit that renewable generation facility property covered by an agreement with a municipality for payments in lieu of property taxes (“PILOTs”) is subject to the State’s equalization process in the same manner as PILOTs covering non-renewable energy property. PILOTs are generally important for renewable energy developers and lenders, as they provide predictability that facilitates project finance. B. Judicial Developments 3 1. Equal Protection Challenge to Right-of-Way. In Northern New England Telephone Operations, LLC D/B/A FairPoint Communications – NNE v. City of Concord, N.H. Supreme Court (Aug. 29, 2014), FairPoint brought an action challenging the constitutionality of the city’s right-of-way property tax assessments against it under the federal and state equal protection clauses. The Superior Court found in favor of FairPoint, implicitly finding that the city had selectively taxed FairPoint, and struck down the tax. On appeal, the Supreme Court vacated the Superior Court rulings on the basis that the Court applied an erroneous legal standard. The matter was remanded for further proceedings. 2. DRA Valuation Upheld. In Appeal of Coos County et al., N.H. Supreme Court (June 18, 2014), the Supreme Court rejected the county’s argument that the DRA’s assessed value of the property was disproportionate and unreasonable on the basis that the utility tax appraisal used by DRA was greater than the PILOT agreement value. Further, the Court held that DRA was not required to consider other evidence when determining the equalized values of the county other than its utility tax appraisal. C. Administrative Developments There are no significant developments. IV. OTHER TAXES A. Legislative Developments 1. Changes to Medicaid Enhancement Tax. The Medicaid Enhancement Tax (“MET”) statute (RSA 84A) was amended during the 2011 legislative session by Chapter 224 (Laws 2011), primarily in response to a ruling of the U.S. Department of Health and Human Services finding that New Hampshire was not following the federal requirements in distributing its disproportionate share payments. As part of these amendments, changes were made to the following provisions of the MET Statute: RSA 84-A:1, III (redefining “hospital”) and RSA 84-A:1, IV-a (redefining “net patient services revenue”). The 2011 Amendments became effective July 1, 2011 (RSA 224:413, XIII), and resulted in litigation that is discussed below. In 2013, Governor Hassan signed into law H.B. 2, creating the Medicaid Enhancement Tax Study Commission, to study the MET laws and possible alternatives. In 2014, S.B. 369 (Ch. 158:1-9, 11, 19, Laws of 2014) was passed, further amending the definitions under the MET statute, making rate changes and specifically removing “specialty hospitals for rehabilitation” from the definition of a taxable “hospital” in part due to a settlement on litigation challenging the constitutionality of the tax as discussed below. 2. Tobacco Tax Documentation. Changes to the tobacco tax were made, effective September 9, 2014, as a result of S.B. 243 (Ch. 192, Laws 2014). S.B. 243 clarified the licensing and tax documentation requirements for sub-jobbers, vending machine operators, retailers or anyone else engaging in the sale, display, shipment, storage, import, transport, carrying or other possession of tobacco products. In addition, S.B. 243 clarified that the lack of tax documentation shall result in the product being contraband and subject to forfeiture. See also TIR 2014-006 (9/8/14). B. Judicial Developments 1. MET Unconstitutional. Following the legislative changes discussed above, multiple hospitals brought suit against the State challenging the constitutionality of the MET. On February 7, 2014, in Northeast Rehabilitation Hospital v. Dep’t of Rev. Admin., 218-2012-CV-00185, the Rockingham Superior Court held the MET, as related to outpatient services, is an unconstitutional classification of taxpayers. Accordingly, the taxpayer (a for-profit hospital) was entitled to a refund for the portion of the MET paid on revenue derived from any outpatient services that were not subject to the MET when provided by non-hospital entities. The Hillsborough County Superior Court went further in Catholic Medical Center v. Dep’t of Rev. Admin., 216-2011-CV-00955 (Apr. 8, 2014) and refused to sever any portion of the MET, holding the entire tax unconstitutional under the Equal Protection clauses of the State and federal constitutions. The court concluded that hospitals received 4 discriminatory treatment under the MET compared to non-hospital entities providing similar services, and that there was no rational basis for such discrimination. Subsequent to the decisions, the State and 25 New Hampshire hospitals entered into an overall settlement agreement resolving the hospitals’ outstanding challenges to the constitutionality of the MET, which included refund claims for the 2014 tax payments, and to Medicaid rate reductions made in previous years. The mechanics of the MET will remain in dispute in the 2015 legislative session. C. Administrative Developments 1. V. Changes to Medicaid Enhancement Tax. In addition to the amendments to the MET statutes discussed above, the DRA amended its MET regulations, at N.H. Administrative Rules, Rev 2300, which became effective April 21, 2011. In doing so, the DRA made substantial revisions to many provisions in Rev 2300, including redefining “net patient services revenue.” However, subsequent to these changes, the DRA began auditing hospitals and other MET taxpayers, and applying these changes retroactively. In the fall of 2013, the DRA also issued a TIR addressing its interpretation of the MET for the first time. As indicated above, the hospitals challenged this application of the regulatory change and resolved all audits as part of the overall state settlement of the pending litigation. On October 2, 2014, the DRA issued guidance briefly summarizing its view of the legislative changes of S.B. 369 (Ch. 158:1-9, 11, 19, Laws of 2014), discussed above. TIR 2014-008. 2015 / 2016 TRENDS A. Budget and Fiscal Outlook. Incumbent Governor Maggie Hassan was reelected to her second term in office during the fall of 2014, defeating challenger Walt Havenstein. On February 12, 2015, Governor Hassan presented her budget address for the upcoming biennium (beginning July 1), proposing a roughly 6.4 percent increase over the prior budget. Governor Hassan’s $11.5 billion budget plan and its companion legislation contained a number of relevant tax proposals. The Governor’s budget package includes voluntary disclosure and amnesty programs, as well as restrictions on the use of off-shore “tax havens,” by erecting a “blacklist” of 39 countries. COST is actively working on this issue, as a standalone bill, H.B. 551, was also introduced. The Governor’s proposal was removed from the House budget (H.B. 2), and an attempt to reinsert the language on the House floor failed by a vote of 234-147. One of the legislative vehicles for the voluntary disclosure and amnesty programs is S.B. 34, which was killed in the Senate, although practitioners expect it to be revived as budget negotiations continue. An alternative bill, S.B. 220, which covers only tax amnesty, was also killed in the Senate, although it too could become the vehicle for both programs during the negotiations. Similarly, the companion legislation to the Governor’s tax haven proposal, H.B. 551, was killed in the House, although practitioners believe it too may be revived. The Governor’s other proposals include increasing the cigarette tax, as well as vehicle registration and boat access fees. Members of the legislature have proposed other changes as well, including amending the RETT as described above, requiring bitcoin be an acceptable method of payment for taxes and fees, and increasing the research and development tax credit against the BPT. B. Additional DRA Staff. In March of 2015, DRA Commissioner John Beardmore testified before the House Ways and Means Committee to request funding to fill up to 12 vacant positions within DRA, including 5 auditors, 2 of which will be dedicated to multistate audits. The Committee unanimously voted to approve the Commissioner’s request, which now requires approval from the House Finance Committee. Governor Hassan emphasized the need to fill these vacancies during her budget address and practitioners anticipate increased audit activity if these positions are filled. Relatedly, the Senate passed S.B. 192, which would establish the new position of “tax policy analyst” within the DRA, and the bill is now before the House Ways and Means committee. 5 C. VI. MTC Audit Program. During his testimony before the House Ways and Means Committee in March, Commissioner Beardmore also recommended that the State join the Multistate Tax Commission audit program. The Committee also unanimously voted to approve the Commissioner’s request, which now requires approval from the House Finance Committee. PROVIDER’S BRIEF BIOGRAPHY/RESUME Christopher J. Sullivan (B.A., Harvard College, 1989; J.D., Georgetown University Law Center, 1996) is a shareholder and tax attorney with a particular focus on state tax matters at Rath, Young and Pignatelli, P.C. Kathryn H. Michaelis (B.A. Kenyon College, 1993; J.D., DePaul University College of Law, 1996; LL.M., in Taxation, DePaul University College of Law, 2000) is a Shareholder with the Tax Practice Group of Rath, Young and Pignatelli, P.C., and was formerly with PricewaterhouseCoopers LLP and the Illinois Department of Revenue in Chicago. William F.J. Ardinger (B.A., University of New Hampshire, 1982; J.D., Harvard University, 1985) is the director of the Tax Practice Group at the Concord, N.H. law firm of Rath, Young and Pignatelli, P.C. Stanley R. Arnold (B.S., Cameron University, 1974; M.B.A., Plymouth State College, 1982; CPA, 1985) served as the Commissioner of the New Hampshire Department of Revenue Administration for 14 years and is currently the Senior Tax Policy Advisor at Rath, Young and Pignatelli, P.C. 6 NEW JERSEY STATE DEVELOPMENTS Spring 2015 www.reedsmith.com/NJtax Kyle O. Sollie David J. Gutowski Reed Smith LLP Reed Smith LLP Three Logan Square Three Logan Square 1717 Arch Street, Suite 3100 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 Philadelphia, PA 19103 Phone: 215-851-8852 Phone: 215-851-8874 Phone: 215-499-6171 Phone: 609-524-2028 [email protected] [email protected] Robert E. Weyman Reed Smith LLP Three Logan Square 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 Phone: 215-851-8160 [email protected] For additional information, articles, and whitepapers, see www.reedsmith.com/njtax. Quick Summary of New Jersey Opportunities 1. Increase Your New Jersey Basis: In Toyota Motor Credit Corp. v. Director and Ford Motor Credit Co. v. Director, the New Jersey Tax Court held that New Jersey couldn’t impose Corporation Business Tax on gains from the disposition of property where the gains were essentially recapture of depreciation deductions that had never produced any tax benefit. As a result, the taxpayers were entitled to a basis adjustment on assets they disposed of during the tax years. Any taxpayer that has realized a gain from the disposition of depreciable property should analyze these cases for potential refund opportunities. For further discussion, see below. 2. Is the Corporation Business Tax Still Voluntary? In BIS LP, Inc. v. Director, the New Jersey Tax Court and Appellate Division determined that a passive, non-resident limited partner with a 99% interest in a partnership doing business in New Jersey is not subject to tax. That case is now final. Meanwhile, in Village Supermarkets, the Division won a limited-partnership nexus case. Village Supermarkets involved a partner that was operationally integrated with the operating partnership. That case has now settled. Further adding to the milieu, the state has passed legislation to address the BIS result. But that legislation is constitutionally suspect. For further discussion, see below. 3. Partnership Level NOLs and Partnership Withholding: The Division is Requiring Excess Withholding. In addition to the nexus issues in the wake of BIS and Village Supermarkets, the Division has been increasing its attention to the partnership withholding tax imposed under N.J.S.A. 54:10A15.11. The Division has been asserting that partnerships are not entitled to carryover net operating losses at the partnership level. Instead, the Division has been demanding that partnerships pay the withholding tax for any income year, without any deduction for a partnership-level loss from a prior year. That position clearly conflicts with the language of the statute. Partnerships, deduct your NOLs! 4. Net Operating Losses. 11-year Carryover. The Division’s position is that most NOLs carried into 2002–2005 get only seven carryover years, despite the fact that the NOLs were suspended during those four years. In our view, those NOLs get an eleven-year carryover. For an explanation, see below. NOLs Absorbed by Dividends. Under New Jersey law, an NOL is absorbed if a taxpayer receives a dividend. Taxpayers that receive a dividend from certain foreign subsidiaries or non-unitary subsidiaries or from E&P generated before the subsidiary was unitary should not be required to Sollie, Gutowski, & Weyman Reed Smith LLP absorb the NOL. Regardless, subsidiary factor representation is appropriate in many cases to fairly reflect income in the year the NOL would otherwise be used. For an explanation of this opportunity, see below. Post-apportionment Carryover. The Division’s position is that a New Jersey NOL carryover must be carried over on a pre-apportionment basis. In many cases, especially if a taxpayer’s apportionment has declined significantly, this results in a diminished value of the NOL carryover. Taxpayers may be entitled to Section 8 (alternative apportionment) relief. One option is to carry over the post-apportioned NOL. This issue may be particularly relevant to New Jersey-concentrated taxpayers whose apportionment percentage will be reduced under New Jersey’s single, market-based sales factor. Exclude Certain 4797 Gains. As discussed above, taxpayers that sold depreciated business property and recognized substantial 4797 gains from depreciation recapture should file refund claims if NOLs could not be carried forward to offset those gains. Conduct R&D Anywhere? Get 15-Year NOL Carryover Period. Prior to 2009, the NOL carry over period was only seven years. But for losses generated in 1999-2001, taxpayers that conducted research activities in New Jersey got a 15-year NOL carryover period. This preferential tax treatment for in-state activities violates the Commerce Clause. Taxpayers with expired NOLs from 1999-2001 that conducted research activities outside of the state should consider filing a refund claim to resurrect those expired losses. 5. Throwout. Under Whirlpool, taxpayers that paid additional tax due to throwout should consider filing refund claims. Takes the position that throwout does not apply to any receipts. This position can find further support in the recent Tax Court order in Lorillard Licensing Co. v. Director, Docket No. 0087722006. For more discussion, see below. 6. Intercompany Interest. It is easy to qualify for an exception to the addback of related-party interest expense and the Division has been favorably settling taxpayer appeals. Any taxpayer that did not claim an addback exception should file a refund claim. 7. Amnesty Penalty. Taxpayers that have been billed (or paid) amnesty penalties should protest the penalties or file a refund claim. The New Jersey Supreme Court has ruled that amnesty penalties should not apply to deficiencies uncovered in a routine audit. For more discussion of the case, see below. 8. Sourcing Intangible and Services Receipts. The Division has withdrawn its proposed market-sourcing regulation for services. The Division continues to take inconsistent positions in pending litigation concerning whether receipts from services and intangibles should be sourced based on the customer’s location or where the underlying activities are performed. Meanwhile, in Whirlpool Properties, the Tax Court will be required to rule on whether licensing intangibles creates New Jersey nexus where the licensee sells licensed products in the state but where the royalty is not computed based on a percentage of sales. Sollie, Gutowski, & Weyman Reed Smith LLP NEW JERSEY STATE DEVELOPMENTS Kyle O. Sollie David J. Gutowski Reed Smith LLP Reed Smith LLP Three Logan Square Three Logan Square 1717 Arch Street, Suite 3100 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 Philadelphia, PA 19103 Phone: 215-851-8852 Phone: 215-851-8874 Phone: 215-499-6171 Phone: 609-524-2028 [email protected] [email protected] Robert E. Weyman Reed Smith LLP Three Logan Square 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 Phone: 215-851-8160 [email protected] For additional information, articles, and whitepapers, see www.reedsmith.com/njtax. I. INCOME/FRANCHISE TAXES A. Legislative Developments 1. Operational Income: In New Jersey, only operational income is subject to apportionment. Under McKesson, income from an I.R.C. § 338 liquidation was deemed non-operational. In response to McKesson, the legislature changed the definition of non-operational income by substituting the word “and” for “or” so that non-operational income is now limited to situations in which the acquisition, management, and disposition of property constitute integral parts of the taxpayer’s business. The new definition is effective for privilege periods ending on or after July 1, 2014. See P.L. 2014, c.13 2. Limiting Refunds for No-Nexus Limited Partners: Under BIS, a nonresident limited partner is entitled to a refund of tax paid on its behalf by the partnership under N.J.S.A. 54:10A-15.11. In response to BIS, the legislature amended the statute to require a nonresident corporation to file a return reporting income subject to tax in New Jersey in order to get a refund. This legislation, which on its face applies only to a “nonresident partner,” discriminates against interstate. Therefore, the law (which takes effect for privilege periods ending on or after July 1, 2014) is likely to be challenged. See P.L. 2014, c.13 § 5. 3. Single Sales Factor: New Jersey has now fully phased in a single sales factor. P.L. 2011, c.59. New Jersey does not conform to UDITPA and its sales factor rules often differ from other states; thus, unique opportunities (and exposures) often exist. 4. Decoupling from Federal Deferral of Discharge of Indebtedness Income: Section 108(i) of the Internal Revenue Code allows businesses that repurchase debt in 2009 and 2010 to defer gain on discharge of indebtedness and then to spread the gain over five years. Under N.J.S.A. 54:10A-4(k)(14), CBT taxpayers must: (i) for privilege periods beginning after December 31, 2008 and before January 1, 2011, include in entire net income the amount of discharge of indebtedness income excluded for federal income tax purposes under I.R.C. § 108(i); and (ii) for privilege periods beginning on or after January 1, 2014 Sollie, Gutowski, & Weyman Reed Smith LLP and before January 1, 2019, exclude the amount of discharge of indebtedness income included for federal income tax purposes under I.R.C. § 108(i). L. 2009, c. 72. 5. Adjusting NOL Carryovers for Discharge of Indebtedness Income: Under new legislation, NOL carryovers must be reduced by discharge-of-indebtedness income excluded from federal taxable income under I.R.C. § 108. The change takes effect for privilege periods ending on or after July 1, 2014. See P.L. 2014, c.13. 6. NOL Carryover Period: The carryover period under N.J.S.A. 54:10A-4(k)(6)(B) is twenty years for a net operating loss generated in any period ending after June 30, 2009. L. 2008, c. 102. This extends the NOL carryover period from seven to twenty years, which is in line with several other states as well as the Internal Revenue Code. For prior periods, there are significant opportunities to increase the amount of the NOL carryovers and also the carryover period itself. 7. Throwout Rule: The sales-fraction “throwout” rule under N.J.S.A. 54:10A-6(B) was repealed for periods beginning on or after July 1, 2010. L. 2008, c. 120. The throwout rule required that a taxpayer exclude from its sales-fraction denominator any receipts that would be assigned to a state where it is not subject to a tax on or measured by profits, income, business presence, or business activity. Taxpayers that paid more tax as a result of throwout should consider filing refund claims. Interestingly, one unfavorable effect of the repeal of throwout is that taxpayers that are protected by P.L. 86-272 may find themselves subject to the Alternative Minimum Assessment, which was repealed effective in 2006 for all taxpayers—except those protected by P.L. 86-272. We believe any taxpayer that is now subject to AMA should challenge that tax because imposing the AMA only on P.L. 86-272 taxpayers clearly discriminates against interstate commerce. 8. Regular Place of Business Requirement: The archaic “regular place of business” requirement under N.J.S.A. 54:10A-6 was repealed for periods beginning on or after July 1, 2010. L. 2008, c. 120. Under this requirement, a taxpayer with nexus outside New Jersey was denied the right to apportion. Even for years before the repeal of this requirement, taxpayers should argue for apportionment under New Jersey’s alternative apportionment statute. See Hess Realty Corp. v. Director, 10 N.J. Tax 63 (1988). 9. Nexus for Transportation Companies: Legislation has been signed into law that provides that a foreign corporation does not have nexus for CBT purposes as a result of the operation of a motor vehicle or bus over public highways or places in New Jersey for carrying passengers in transit from a location outside the state to a New Jersey destination or from inside the state to a destination outside of New Jersey. P.L. 2013, c.98. 10. Grow New Jersey—Economic Development Legislation: The New Jersey Economic Opportunity Act of 2014 again changed New Jersey’s incentive landscape. P.L. 2014, c. 23. The 2014 Act made several changes to the Grow New Jersey program. Among other things, the Act increased bonuses for investing in Camden and increased the investment requirements to qualify for job retention credits. 11. Angel Investor Tax Credit Program Created: The “NJ Angel Investor Tax Credit Act” is intended to encourage investment in New Jersey emerging technology businesses. These businesses include those with fewer than 225 employees and 75% of their workforce in New Jersey in a number of targeted industries. The enacted law provides a tax credit of Sollie, Gutowski, & Weyman Reed Smith LLP up to 10% of the angel investor’s investment in the emerging technology business. The credits can be applied against the corporation business tax or gross income tax and excess amounts can be refunded or carried forward for 15 years. Credits are limited to $500,000 per investment. P.L. 2013, c.14. B. Judicial Developments 1. State Tax Addbacks: For CBT purposes, state taxes must be added back to line 28 taxable income to the extent they were “on or measured by profits or income, or business presence of business activity.” N.J.S.A. 54:10A-4(k)(2)(C). Historically, the Division has broadly applied this addback—even to taxes paid based on gross receipts and net worth. In PPL Electric Utilities Corporation v. Director, 28 N.J. Tax 128 (N.J. Tax 2014), the court considered a Pennsylvania gross receipts tax calculated according to the actual sale of electricity in Pennsylvania. Since it was based solely on the amount of electricity sold (not the taxpayer’s business presence or business activity) and applied regardless of whether the taxpayer realized income or profit from such sales, the court concluded that the tax was not required to be added back to entire net income. The court further concluded that the Pennsylvania Capital Stock Tax was a property tax and thus was not required to be included in entire net income. Rather, the only state taxes required to be added back were “taxes similar to that of the CBT.” The Tax Court provided further analysis of the add back statute in Duke Energy Corp. v. Director, 28 N.J. Tax 226 (N.J. Tax 2014). It concluded that: “The legislative history of N.J.S.A. 54:10A-4(k)(2)(C) clearly indicates that the add back provision is intended to capture only taxes paid to other States on a taxpayer’s net corporate income.” Taxpayers that added back net worth taxes and gross receipts taxes in prior years should consider filing a refund claim. 2. Intercompany Interest: New Jersey requires an addback of interest paid to an affiliate unless an exception applies. One of the exceptions is an “unreasonableness” exception. The Division has interpreted that exception to apply only if the taxpayer demonstrates that tax was paid to another state on the interest received by the affiliate—if that criterion isn’t met, the Division refuses to look further. The New Jersey Tax Court determined that the statute does not require a tax to be paid to qualify for the “unreasonableness” exception. By refusing to look beyond that criterion, the Tax Court determined that the Division abused its discretion. Therefore, the court ordered the Division to allow the deduction. Morgan Stanley & Co. v. Director, 2014 N.J. Tax Lexis 23. 3. Limited Partner Nexus: BIS LP, Inc. was a 99% limited partner in a partnership (“Solutions”). Solutions conducted a banking information processing and outsourcing business in New Jersey. But BIS itself had no property or payroll in New Jersey; its only connection to New Jersey was its interest in Solutions. BIS, as the limited partner, was not permitted to participate in the active management of Solutions. Rather, Solutions’ business was managed by the general partner, who was also the 100% owner of BIS. The Tax Court and Appellate Division held that BIS and Solutions were not integrally related and that BIS lacked sufficient constitutional presence to be subject to tax in New Jersey. BIS LP, Inc. v. Director, 25 N.J. Tax 88 (Tax 2009); aff’d Dckt No. A-1172-09T2 (N.J. Sup Ct. App. Div. Aug. 23, 2011). Solutions had paid a withholding tax with respect to BIS’s share of its income On remand, the Tax Court held that the limited partner, BIS, should receive the refund on Sollie, Gutowski, & Weyman Reed Smith LLP account of the tax paid on its behalf by Solutions. See BIS LP v. Director, Docket No. 007847-2007 (New Jersey Tax Court, October 25, 2012). The Appellate Division affirmed in an April 11, 2014 order. That case is now final. Meanwhile, The Division won a case in Tax Court by proving, through a multi-day trial, that a limited partner and limited partnership were operationally integrated. Thus, the limited partner had nexus. Village Supermarkets of PA, Inc. v. Director, N.J. Tax Court Docket No. 021002-2010 (Oct. 23, 2013). That case has been settled on appeal. Therefore, corporate partners whose only contact with New Jersey is a limited partnership interest that have paid CBT may still be entitled to a refund—especially if the limited partner is merely a holding company or is not otherwise operationally integrated with the limited partnership. 4. Apportioning the Income of a Corporate Partner: Even if a corporate partner has nexus with New Jersey based on its own activities, it may still have a refund opportunity in light of the BIS decision. Under N.J.A.C. 18:7-7.6(g), if a corporate partner is not unitary with the underlying partnership, the partner must complete its tax using the separate accounting method. The corporate partner apportions its distributive share of the partnership income using the partnership’s apportionment factors, then separately computes tax on its non-partnership income using its own property, payroll, and sales. If this method produces less tax than the “flow-up” method, then the corporate partner should file a refund claim. 5. Limitation on the McKesson Liquidation Exception: In McKesson Water Products Co. v. Director, 408 N.J. Super. 213 (App. Div. 2009), aff’g, 23 N.J. Tax 449 (Tax 2007), the Appellate Division held that a taxpayer’s gain from a deemed asset sale under I.R.C. 338(h)(10) was nonoperational income under N.J.S.A. 54:10A-6.1 (and thus not includable in the taxpayer’s apportionable tax base). The court reasoned that in order for the gain to be operational income “the acquisition, management, and disposition of the property [must] constitute integral parts of the taxpayer’s regular trade or business operations ….” Since the transaction at issue resulted in the cessation of a line of business with a complete liquidation and distribution of the proceeds of the sale to the taxpayer’s parent, this was an extraordinary event and, thus, the gain was not operational income. More recently, the Tax Court distinguished McKesson in Elan Pharmaceuticals, Inc. v. Director, N.J. Tax Court Docket No. 010589-2010 (May 2, 2014), which involved a pharmaceutical company’s sale of the U.S. and Canadian markets and New Jerseybased manufacturing facility of its subsidiary (another pharmaceutical company producing cancer drugs). The court found that the business lines and facility sold constituted integral and regular parts of the taxpayer’s business. 6. Amnesty Penalty: In United Parcel Service, the Division also attempted to impose a fivepercent amnesty penalty pursuant to N.J.S.A. 54:53-17(b) and -18(b), which applies to “tax liabilities eligible to be satisfied during the period established pursuant to subsection a. of this section that were not satisfied during the amnesty period.” The Tax Court interpreted “tax liabilities eligible to be satisfied … to refer to liabilities which, during the applicable amnesty period, were known to the taxpayer or which, by reasonable inquiry, could have been known.” Based on the circumstances of this case, the court concluded that the amnesty penalty could not be imposed because the taxes were not “eligible to be satisfied” during the amnesty period. The court reasoned that during the amnesty period the taxpayer acted in good faith and did not know and by reasonable inquiry could not Sollie, Gutowski, & Weyman Reed Smith LLP have known that additional taxes were due, or that the Division claimed that additional taxes were due. The New Jersey Appellate Division upheld the Tax Court’s decision that the amnesty penalty should not be imposed based on the notion that a tax liability was not finally determined until the state issues its assessment of additional tax due. United Parcel Services General Services Co. v. Director, 430 N.J. Super 1 (App. Div. March 7, 2013). The New Jersey Supreme Court upheld the decision of the Appellate Division in December 2014. United Parcel Services General Services Co. v. Director, 220 N.J. 90 (2014). Thus, the case is final. The UPS case is noteworthy for taxpayers assessed amnesty penalties related to the 2009 amnesty that ended on June 15, 2009 because the 2009 amnesty statute also contains the identical statutory imposition of the amnesty penalty. Thus, any taxpayer that has paid, in the last 4 years, an amnesty penalty on any assessment may claim a refund of that penalty—so long as the underlying position was reasonable. By contrast, if a taxpayer takes a position on a return that is contrary to “long settled” law and there is no “genuine question of fact or law” to support the position, the amnesty penalty will be sustained. De Rosa v. Director, 2015 N.J. Tax Lexis 1 (Jan. 22, 2015). 7. Facial Challenge to the Throwout Rule: On July 28, 2011, the Supreme Court issued its opinion regarding the facial constitutionality of New Jersey’s sales factor throwout rule. The court ruled that New Jersey's throwout rule is constitutional, generally. But the court limited its ruling in that throwout may apply constitutionally only to untaxed receipts from states that lack jurisdiction to tax the corporation due to insufficient nexus, but not to receipts that are untaxed because a state chooses not to impose an income tax. According to the court, another state’s policy choices should have no bearing on the application of New Jersey's throwout rule. The court's decision significantly limits the application of throwout. The throwout rule statute requires a taxpayer to exclude receipts from the sales-fraction denominator if sourced to a state in which the taxpayer is "not subject to a tax." New Jersey's nexus rules are among the broadest in the country and if those same nexus standards are applied for throwout purposes (i.e., for purposes of determining whether a taxpayer "is subject to a tax" in another state), then a taxpayer will have sufficient constitutional nexus nearly everywhere. As a result, throwout arguably should not apply to any receipts. Indeed, even if a taxpayer's activities do not exceed P.L. 86-272, throwout should arguably not apply based on the court’s reasoning in Whirlpool. Another state's decision to impose an income tax (as opposed to a gross receipts tax that is not restrained by P.L. 86-272) is a policy choice. And another state's policy choices, according to the court, should not affect the throwout computation. Therefore, throwout should not apply even to receipts sourced to states in which the taxpayer is P.L. 86-272 protected. After Whirlpool, the Division of Taxation issued a notice dated September 7, 2011, that it will not throw out the receipts of Nevada, Wyoming, and South Dakota because those states have chosen not to impose a business activity tax. Otherwise, the Division stated that its throwout policy will be unchanged. Notwithstanding the Division’s guidance, any taxpayer that paid more tax as a result of throwout should consider filing refund claims based on Whirlpool. Sollie, Gutowski, & Weyman Reed Smith LLP Currently, the Whirlpool case is before the Tax Court for a determination of whether, in light of the Supreme Court’s holding, the throwout rule can be applied constitutionally to the taxpayer. Oral argument before the Tax Court was held in July 2013. In October 2013, however, the court ruled that factual issues remained unresolved and denied the parties’ motions for summary judgment. In particular, the court determined it was unclear whether Whirlpool even has nexus with New Jersey. Although Whirlpool licensed trade names and marks to an affiliate, the royalty was not computed based on the licensee’s sales. The court distinguished this situation from the typical Lanco-type arrangement. If a taxpayer licenses intangibles based on a flat fee or a percentage of costs (rather than a percentage of sales), it should consider filing a protective refund claim. 8. Ongoing Litigation over Throwout—the Lorillard case: In August 2013, New Jersey Tax Court ruled that throwout doesn’t apply to an intangible holding company’s royalty receipts. Lorillard Licensing Co. v. Director, Docket No. 008772-2006. Lorillard involved an intangible holding company that licensed trademarks and trade names to an affiliated operating company. In exchange, the affiliate paid Lorillard a royalty based on a percentage of the affiliate’s sales; the royalty arrangement covered the entire United States. The Division of Taxation applied throwout and excluded non-sourced sales from the denominator of its sales fraction. This resulted in sourcing 100% of Lorillard’s sales to New Jersey. Lorillard argued that none of its receipts could be thrown out. The Tax Court agreed with Lorillard and issued an unpublished opinion on January 14, 2014. Any taxpayer that paid more tax under the throwout rule should file a refund claim. This includes taxpayers that excluded receipts sourced to states in which they were immune from income tax under P.L. 86-272 or that involved intercompany transactions that got eliminated on a unitary-combined return. 9. Excluding Depreciation Recovery Gain from Entire Net Income: In Toyota Motor Credit Corp. v. Director, 28 N.J. Tax 96 (Aug. 1, 2014) and Ford Motor Credit Co. v. Director, N.J. Tax Court Docket No. 015751-2009 (August 5, 2014), the Tax Court allowed the taxpayers to adjust the basis of disposed vehicles because the taxpayers had not realized any tax benefit from the related depreciation deductions. (The depreciation deductions had generated losses that couldn’t be used because of New Jersey’s NOL suspensions.) 10. Statute of Limitations for Deficiency Notices: The Tax Court held that the 3–year limitations period for deficiency notices in N.J.S.A. 54A:9-4(a) begins to run from the date of the original tax return rather than the date of the amended return. DiStefano v. Director, 23 N.J. Tax 609 (Tax 2008). This case involved the Gross Income Tax and the statute of limitations provisions relevant to that tax. The Tax Court’s rationale may, however, also apply in the CBT context. (The Division’s position has been that filing an amended return refreshes the four year statute of limitations for assessment.) Any taxpayer that is facing an assessment for a period that would be closed but for the filing of an amended return should challenge the statute of limitations on the basis of DiStefano. 11. Limited discretion to adjust line 28 taxable income: Taxpayers earned extraterritorial income that was included in their line 28 taxable income for federal income tax purposes. The Division issued an assessment on the basis that income from sources outside of the United States must be added-back to federal taxable income in order to calculate net Sollie, Gutowski, & Weyman Reed Smith LLP income for CBT purposes. The Taxpayers appealed and the Tax Court ruled that the Legislature never expressly adopted a provision requiring taxpayers to add-back extraterritorial income in their New Jersey tax base. International Business Machines Corporation, et al., v. Director, N.J. Tax Court Docket No. 011795-2009 (2011). Similarly, foreign taxpayers should not include income in their CBT base unless it was reported on line 29 of their federal Form 1120-F. Taxpayers that paid CBT on such income should file a refund claim. 12. Sourcing of Intangible Income: There is pending litigation on whether income from financial transactions should be sourced based on the payor’s location or where the services were performed. There is also pending litigation on whether technology-related services should be sourced based on market or where the services were performed. The Division is taking inconsistent positions in these cases. Therefore, taxpayers should source their income from intangibles based on the method that results in the least amount of tax. 13. Net Operating Loss Suspension—4 more years: There is litigation pending on whether NOLs that carried over into the 2002–2005 suspension period are always extended by 4 years. Under the statute, a 2001 loss that would ordinarily expire after 2008 doesn’t expire until after 2012 because it gets four additional carryover years. A 2002 loss that would ordinarily expire after 2009 would get a three year extension for the three years after 2002 in the suspension period, so that loss would also expire in 2012. The Division of Taxation, however, promulgated a regulation in 2007 that limits the fouryear extension. If the regulation were upheld by the courts, the regulation would limit the extension to only those NOLs that would have otherwise expired during the four year 2002–2005 suspension period. So a 2001 NOL would get no additional carryover years because it is scheduled, under the ordinary seven year carryover period, to expire in 2008. This regulation is not supported by the statute. The better rule, as a matter of statutory construction and as a matter of sound tax policy, is that any loss carried into the 2002– 2005 suspension period should be extended by four years. Therefore, taxpayers with significant losses should consider using the statutory rule rather than the Division’s rule. C. Administrative Developments 1. Market Sourcing Regulations for Services: The Division has withdrawn its proposed market-sourcing regulation for services. Under the proposed regulation, service receipts would have been sourced based on the location of the customer or benefit received— regardless of where the services were performed. While the regulation was withdrawn, the Legislature may decide to make such a change in light of the full phase-in of single sales factor reform. In any case, the proposed regulation evidences the fact that New Jersey is not a strict cost-of-performance state. The Division employs different methods based on the taxpayer’s specific facts and circumstances. With New Jersey’s move to a single sales factor, now is a good time for taxpayers to evaluate their sourcing method for services receipts. 2. Intercompany Transfer Pricing and Related Party Transactions: The Division issued a TAM regarding the treatment of intercompany and related-party transactions. In general, it seems the Division will adhere to federal transfer-pricing principles and provide great weight to Advanced Pricing Agreements with the Internal Revenue Service and transfer Sollie, Gutowski, & Weyman Reed Smith LLP pricing studies that form the basis of an APA. The Division intends to codify the TAM in a regulation. TAM 2012-1-CBT 3. Add Back of Related Member Interest Expense: On February 24, 2011, the Division issued a Technical Advisory Memorandum clarifying its interpretation of the statutory exceptions to add-back under N.J.S.A. 54:10A-4(k)(2)(I). Specifically, the memorandum outlines (1) the Division’s interpretation of the “three percent tax rate”, “foreign nation” and “conduit guarantee” exceptions; and (2) fact patterns that would qualify for the “unreasonable” and “alternative apportionment method” exceptions. TAM 2011 – 13 – CBT. The memorandum contradicts the Beneficial decision in that the Division states that taxpayers have to show evidence that (1) there is a flow of actual funds rather than book and accounting entries; (2) that the loan is memorialized in an agreement executed at the time of loan origination; and (3) the related lender must pay income tax on the interest income in at least 12 other separate company jurisdictions. These requirements do not follow from the Beneficial decision. To the extent that the TAM contradicts Beneficial, it should be disregarded. 4. D. Sourcing Gift Card Redemption Fees: The Division has issued a letter ruling regarding the sourcing of redemption fees received by a taxpayer that issues and sells stored value cards, gift cards, gift certificates and similar items. Where the redemption fees are attributable to consumer gift care redemption events at retail store location in New Jersey, the fees are sourced to New Jersey and must be included in the numerator of the sales factor. Income recognized from gift card payments attributable to breakage and deferred unredeemed gift card balances must be included in the sales factor numerator based on the percentage of gift card redemption fees sourced to New Jersey. Any miscellaneous investment income that the taxpayer earns from the investment of cash on hand must be sourced to the taxpayer’s commercial domicile. Letter Ruling 2012-5-CBT (June 29, 2012). Trends/Outlook for 2014 1. 2. Nexus: a. Intercompany Lending: The Division has ruled that performing corporate treasury functions for a New Jersey-based affiliate creates CBT nexus. b. Licensing Intangibles: The Division has expanded the nexus rule of Lanco, Inc. v. Director, 908 A.2d 176 (N.J. 2006) beyond that facts in that case, which involved an IHC that licensed trademarks to an affiliate. The Division’s policy is that licensing other intangibles, such as patents, can create CBT nexus—even if the licensee’s manufacturing activities are performed outside New Jersey. The Division has also ruled that licensing intangibles to non-affiliates creates nexus. The courts will have an opportunity to limit New Jersey’s nexus standards in Whirlpool Properties, which involves the issue of whether Lanco applies only to royalties that are computed based on a percentage of the licensee’s sales. Net Operating Loss Suspension—4 more years: New Jersey suspended, in whole (in 2002–2003) and in part (2004–2005), the deductibility of NOLs during the period 2002 through 2005. The legislation that suspended the deductions for this four-year period gave taxpayers the right to extend the normal seven-year carryover period by four years Sollie, Gutowski, & Weyman Reed Smith LLP for any loss carried into the period of suspension (or less, if the loss was generated during the suspension period). The Division of Taxation, however, promulgated a regulation in 2007 that limits the extension to only those NOLs that would have otherwise expired during the four year 2002–2005 suspension period. This regulation is not supported by the statute. The better rule, as a matter of statutory construction and as a matter of sound tax policy, is that any loss carried into the 2002– 2005 suspension period should be extended by four years. Therefore, taxpayers with significant losses should consider using the statutory rule (see far right column of table) rather than the Division’s rule. Statutory Division’s Rule: NOL Tax Period Of Without Suspension Rule: NOL Expires Expires After After Loss NOL Expires After 2004 2011 2011 2012 2003 2010 2010 2012 2002 2009 2009 2012 2001 2008 2008 2012 2000 2007 2007 2011 1999 2006 2006 2010 1998 2005 2006 2009 1997 2004 2006 2008 1996 2003 2006 2007 1995 2002 2006 2006 We encourage any taxpayer to consider using the carryover period listed in the “statutory rule” column of this table rather than the period listed in the “Division’s rule” column. 3. Foreign Dividends: If your company made a major repatriation of foreign earnings, consider this issue. Under New Jersey law, the dividend received deduction is computed after the deduction for NOL carryovers. Thus, a dividend, even if it will be deducted by virtue of a DRD, absorbs NOLs. Many taxpayers have had significant dividends under the American Jobs Act. Those dividends have been paid, often, by foreign corporations that are managed and operated completely separate from the domestic business. Because of water’s edge treatment in many unitary states and Kraft-mandated dividend received deductions in many separate reporting states, taxpayers have not focused on whether those dividend-paying subsidiaries are unitary because the dividends are excluded from income regardless. But if the subsidiary is not unitary, then the dividend paid by the subsidiary should not absorb the NOL carryover of the unitary group. After all, under Hunt Wesson, a state cannot tax by indirect means what it cannot tax by direct means. So if New Jersey cannot impose a tax on a dividend from a foreign subsidiary because that foreign subsidiary is separately managed and thus not unitary, then New Jersey cannot reduce the NOL of the taxpayer by reference to that dividend. Sollie, Gutowski, & Weyman Reed Smith LLP As a consequence, taxpayers that received a § 965 dividend from foreign subsidiaries or other foreign dividends should consider the authority of the ASARCO and Woolworth cases, in which the Supreme Court determined that foreign subsidiaries engaged in the same business as the domestic parent were, nonetheless, not unitary with the domestic parent if the subsidiaries were sufficiently independent. If your foreign subsidiaries are also not unitary, then your New Jersey NOL should not be reduced by the amount of the foreign dividend. 4. Intercompany Interest: In August 2010, the Tax Court issued a decision addressing New Jersey’s addback of deductions for interest paid to affiliates. See Beneficial New Jersey, Inc. v. Director, N.J. Tax. Court No. 009886-07. The Division has settled other intercompany interest cases. See, e.g., Household Finance Corp. III v. Director, N.J. Tax Court No. 009890-07; Morgan Stanley & Co., Inc. v. Director, N.J. Tax Court Docket No. 007557-07; Mark IV IVHS, Inc. v. Director, N.J. Tax Court No. 001671-2009. a. Cash Sweep Arrangement: After the addback statute was enacted, the Division published various informal guidance suggesting that there is a “cash sweep” exception to the addback of related party interest. Under a cash sweep arrangement, one affiliate manages the excess cash and short-term funding requirements for other affiliates. As discussed above, in Beneficial New Jersey, Inc. v. Director, N.J. Tax Court Docket No. 009886-07 (decision issued August 31, 2010), the Tax Court concluded that it was unreasonable for the taxpayer to addback interest paid to its parent as part of a cash sweep arrangement. Further, the Division acknowledged a limited cash sweep exception in TAM 2011-13. Therefore, any taxpayer that has increased entire net income as a result of an intercompany cash management arrangement should consider filing a refund claim. b. Offsetting Interest Income and Interest Expense: In Morgan Stanley & Co., Inc. v. Director, N.J. Tax Court Docket No. 007557-07, the taxpayer borrowed funds from affiliates and paid interest on those amounts. Meanwhile, during the same tax year, the taxpayer earned interest income on amounts lent to affiliates. In computing its New Jersey addback for interest paid to affiliates, the taxpayer netted the two amounts and added back only the net interest expense. The Division did not agree with the taxpayer’s approach. The Division assessed additional tax under the view that the taxpayer must add back the interest paid to affiliates, while recognizing in full the interest received from affiliates. This case was settled and in TAM 2011-13 (described above), the Division conceded this netting approach. c. Interest Imputation: In UPS and Mark IV IVHS, Inc., taxpayers were challenging the Division’s efforts to impute interest in various situations. Generally, the taxpayers were challenging whether the intercompany balances are appropriate for imputation of interest and, if they are, whether the balances should be netted and whether the rate applied on the net balances is appropriate. The taxpayer in Mark IV case negotiated a favorable settlement of its case. Mark IV IVHS, Inc. v. Director, N.J. Tax Court No. 001671-2009. As discussed above, the tax court issued a decision in UPS in June 2009. Sollie, Gutowski, & Weyman Reed Smith LLP 5. Throwout: After the New Jersey Supreme Court’s decision in Whirlpool Properties, Inc. v. Director, and the Tax Court’s recent order in Lorillard Licensing Co. v. Director, taxpayers should consider filing returns or refund claims on the basis that throwout no longer applies to any receipts. Furthermore, the Supreme Court only addressed the facial constitutionality of throwout; other issues have been raised in Whirlpool and other appeals. For example, taxpayers are seeking relief based on the as-applied issue (i.e., whether throwout is unconstitutional or unfair as applied to the particular taxpayer’s facts). The as-applied issue involves looking at the distortion that results from applying throwout. Taxpayers are also seeking relief based on whether the $5 million cap discriminates against out-of-state companies. These issues can apply regardless of the amount of distortion involved. II. 6. Subjecting Out-of-State Financial Services Companies to CBT: The Division’s regulation creates a broad nexus rule for financial services companies. N.J.A.C. 18:7-1.8(b). Given the retroactive nature of this regulation despite the fact that it is directly contrary to prior guidance from the Division and Court decisions that limit the Division’s broad nexus standards, taxpayer’s should consider challenging the application of this regulation. 7. Sourcing Receipts from Intangibles: The courts will likely provide guidance concerning whether intangible receipts are sourced based on market principles or instead based on the taxpayer’s commercial domicile, or where the relevant activities are performed. SALES AND USE TAXES A. Legislative Developments: 1. Printed Advertising Material Exemption: In late 2008, New Jersey amended its statute to bring it into conformity with various Streamlined requirements. P.L. 2008, c. 123, Introduced as New Jersey Assembly Bill A3111 (Approved December 19, 2008). But the amendment also contained some little-noticed changes to the exemption for direct mail advertising. These changes provide a refund opportunity for taxpayers that ship printed advertising materials from New Jersey. Historically, New Jersey had a broad exemption for printed advertising materials shipped out of state. In 2005, New Jersey narrowed its direct mail exemption (N.J.S.A. §54:32B8.39) so that it applied only to paper advertising materials or other printed advertising materials shipped with printed paper advertising material. Also, beginning in 2005, the exemption did not apply if the materials were shipped to a single address, for example a bulk shipment of advertising to a sales representative. Under the 2008 amendment, however, the exemption is effectively returned to its original form. As a result, all printed advertising material (not just advertising material printed on paper) that is shipped outside New Jersey should qualify for exemption—even if the material is shipped to a single address. Vendors may still be charging tax based on the 2005 rule, however. So taxpayers that file refund claims should expect resistance from the Division, which published a notice that the new law “does not result in a change of taxability from prior law.” 2. Employee Leasing Services: The legislature clarified the tax liabilities of client companies and employee leasing companies in the event that the sales and use tax were to be applied prospectively to employee leasing services. The statutory amendment provides that any sales tax imposed on employee leasing services would only apply to the vendor’s mark-up. P.L. 2011, c.118. Sollie, Gutowski, & Weyman Reed Smith LLP 3. Nexus: The definition of “seller” under the Sales and Use Tax Act for sales occurring on or after July 1, 2014 has been modified to create a rebuttable presumption that an out-ofstate seller who makes taxable sales of tangible personal property, specified digital products, or services is soliciting business and has nexus in New Jersey if: 1) the seller enters into an agreement with a New Jersey independent contractor for compensation in exchange for referring customers via a link on its website to the out-of-state seller; and 2) has sales from those referrals to customers in New Jersey in excess of $10,000 for the prior 4 quarterly periods. N.J.S.A. 54:32B-2(i)(1). B. Judicial Developments 1. Manufacturing Exemption and Capital Improvements: On February 14, 2012, the New Jersey Tax Court determined that the manufacturing exemption did not apply to supplies, parts and equipment located in the taxpayer’s paper manufacturing facility. In rejecting numerous factual assertions by the taxpayer, the court afforded great weight to how the taxpayer treated the disputed items for federal tax and accounting purposes. In this case, the taxpayer's accounting treatment was not consistent with its position for New Jersey sales tax purposes and the taxpayer was unable to overcome the statutory presumption of taxability. Taxpayers should be mindful, therefore, that how an item is treated for accounting and federal tax purposes can have New Jersey sales tax implications. Schweitzer-Mauduit International Inc. v. Director, N.J. Tax Court Docket No. 0073762005 (2012), affirmed by Schweitzer-Mauduit International Inc. v. Director, New Jersey Appellate Division Docket No. A-3946-11T2 (April 30, 2013). 2. Refund Projection and Issue Preservation: The taxpayer's appeal involved both an assessment appeal and a refund claim. Although the court denied substantially all of the taxpayer's requested relief, it agreed that the taxpayer had erroneously paid tax of $98.35 on certain parts for manufacturing equipment. Since the overpayment was included in the sample month selected by the auditor to compute the Division of Taxation's projected assessment, the taxpayer asserted that it should be able to similarly project its refund. The court, however, refused to project the refund. The court concluded that the Division had broad discretion to use sampling methods to calculate assessments, but denied the taxpayer the same right to project overpayments. Schweitzer-Mauduit International Inc. v. Director, N.J. Tax Court Docket No. 007376-2005 (2012). This seems inconsistent with the principles in the Taxpayer Bill of Rights, P.L. 1992, c.175, which guarantees “consistent treatment for assessments and refunds.” See N.J. Division of Taxation, Publication ANJ-1 (December 2004). Therefore, despite the Tax Court's decision, taxpayers should continue to press the Division of Taxation to project overpayments in the same manner as underpayments. The Court also prohibited the taxpayer from raising new issues at trial. The Court noted that there was “no evidence that any of the new claims for exempt treatment had been raised with [the hearing officer] during the course of the administrative protest.” The Court’s ruling is consistent with United Parcel Services General Services Co. v. Director, 25 N.J. Tax 1 (Tax 2009). In that case, the Court held that a taxpayer couldn’t rely on information at trial if it wasn’t provided during the audit process. This reinforces the importance of raising all issues and documentation before getting to Court. Otherwise, a taxpayer may be precluded from raising those issues later. Sollie, Gutowski, & Weyman Reed Smith LLP The Appellate Division subsequently affirmed the Tax Court’s decision in an opinion issued on April 30, 2013. Schweitzer-Mauduit International Inc. v. Director, New Jersey Appellate Division Docket No. A-3946-11T2 (April 30, 2013). 3. Charges for Distribution of Electricity: The Tax Court has determined that the amount charged for the distribution of electricity through the local distribution infrastructure to a consumer is subject to sales tax as receipts from the transportation of transmission of natural gas or electricity (by means of mains, wires, lines, or pipes) to users and consumers. Furthermore, the Court also clarified that all of the charges (authorized by the Legislature and Board of Public Utilities) imposed on customers to recover expenses associated with electricity generation, demand management, customer services, energyrelated social programs, and other costs should be included in receipts from utility services for purposes of calculating the sales tax due to the state as the total amount of consideration paid for those services. Atlantic City Showboat, Inc. v. Director, N.J. Tax Court Docket No. 000036-2007 (2012). The Tax Court’s decision was sustained. Atlantic City Showboat Inc. v. Director, 2013 N.J. Tax LEXIS 25, cert. denied 217 N.J. 303 (2014). 4. Septic Waste System Cleaning and Disposal: Taxpayer operated a septic cleaning and disposal firm and argued that charges for transportation and disposal of the waste were not taxable regardless of how they were identified on the customer invoices. The Division countered that the charges for transportation and disposal had to be specifically identified on the invoices for the services to be nontaxable. Alternatively, the Division also argued that even if the charges had been separately listed on the invoices, all the services provided by the taxpayer were taxable because the object of the transaction was removal of the waste from the septic tanks and not the transportation of the waste. The Tax Court ruled in favor of the Division and this ruling was upheld by the New Jersey Superior Court, Appellate Division. English Sewage Disposal, Inc. v. Director, Docket No. A-4539-10T1 (N.J. Super. A.D. 2012). 5. Recycling Equipment Exemption: The New Jersey Tax Court ruled that an excavator and a skid loader used by the taxpayer in a tree recycling business qualified for the recycling equipment exemption pursuant to N.J.S.A. 54:32B-8.36(a). The Division of Taxation agreed that the taxpayer did in fact only use the equipment for recycling, but argued that the equipment was not exempt because it could be used for general construction activities. The Tax Court ruled that the fact that the equipment could be used for general construction did not disqualify the equipment from the exemption. The court reasoned that the statute requires there to be exclusive use in the recycling process; but does not require that the equipment be only capable of use in the recycling process. Becker’s Tree Service v. Director, N.J. Tax Court Docket No. 006203-2007 (2013). 6. Storage and Manufacturing Exemptions: The New Jersey Tax Court ruled that purchases of parts that a taxpayer shipped into New Jersey to assemble pretzel warmers did not qualify for the storage exemption as property assembled by the taxpayer and merely stored in New Jersey before being shipped out-of-state. The Tax Court also found that the pretzel warmers were not used in manufacturing. The taxpayer sells frozen pretzels to pretzel vendors, and also sells or loans pretzel warmers to vendors that request them. When a customer requests a pretzel warmer, the taxpayer orders the necessary parts and ships them into New Jersey where the pretzel warmer is assembled and shipped to its customers. Following an earlier administrative Sollie, Gutowski, & Weyman Reed Smith LLP determination, the taxpayer only paid tax on parts attributable to pretzel warmers that it shipped to customers in New Jersey. At audit, the Division imposed use tax on all parts shipped into New Jersey. The Tax Court upheld the assessment, first finding that the taxpayer did not store the parts in New Jersey because the parts were only ordered once a pretzel warmer was requested by a customer and the pretzel warmer was quickly shipped to customers once the pretzel warmers were assembled. The Court distinguished the taxpayers facts from Cosmair, Inc. v. Director, 109 N.J. 562 (1988), and found that while the taxpayer assembled the pretzel warmers, the parts were not actually stored in New Jersey or withdrawn from storage for purposes of N.J.S.A. 54:32B-6(B). The Court also found that the parts used to create the pretzel warmers did not qualify as “machinery, apparatus, or equipment” necessary to qualify for the manufacturing exemption. It also found that the pretzel warmers themselves were not used by the taxpayer in manufacturing process since the taxpayer manufactured frozen pretzels, and the warmers were not integral to that process. Finally, the Court rejected the taxpayer’s equitable estoppel argument based on the Division’s prior administrative treatment of its parts purchases, however, the Court did strike penalties and interest. J&J Snack Food Sales Corp. v. Director, N.J. Tax Court Docket No. 004986-2012 (2013). 7. Urban Enterprise Zone Refund Claim Rejected as Untimely: The Tax Court upheld the Division’s narrow reading of the statute of limitations for refund claims related to the UEZ sales tax exemption. A law firm filed refund claims for tax periods January 1, 2008 through March 31, 2012 on purchases of property and services sourced to its Newark office, which was located in a designated urban enterprise zone. The Division denied the majority of the refund claim on the basis that the one year statute of limitations to claim the UEZ sales tax exemption had expired. On appeal, the taxpayer argued that the statute of limitations was four years for UEZ sales tax refunds, consistent with the standard statute of limitations for sales tax refunds in New Jersey. The Tax Court disagreed and concluded that the statutory language unambiguously limited the statute of limitations to one year from the payment of the tax. In addition, the taxpayer argued that the limitations period was held open by a waiver to extend the period for issuing an assessment. Again, the Court disagreed, noting that the statute of limitations had already expired by the time the waiver was executed. McCarter & English v. Director, N.J. Tax Court Docket No. 000541-2013 (2014). 8. No Mailbox Rule in New Jersey: Highlighting a potential trap for the unwary, the Tax Court ruled that for purposes of the statute of limitations, a Tax Court complaint is deemed filed on the day it is received by the Court, not the mailing date. In this case, the taxpayer’s complaint was sent by certified mail within ninety days of the Division’s Final Determination; however, it was not received by the Tax Court until after the ninety days had expired. The Court ruled that because the Tax Court did not receive the complaint until after the 90 days had passed, the court lacked jurisdiction to review the case. Smart Publications, LLC et al. v. Director, Docket No. A-3516-13, N.J. Tax Court Docket No. 012506-2013. 9. Wrapping Supply Exemption Upheld for Packaging Shipped to Related Entity: The New Jersey Tax Court granted a taxpayer’s motion for summary judgment finding that purchases of wrapping supplies by a warehouse company used to ship merchandise to Sollie, Gutowski, & Weyman Reed Smith LLP retail stores owned by various affiliated entities were exempt from tax. The taxpayer received merchandise from third-parties that it then repackaged and shipped to affiliated retail stores, and filed a refund claim for tax paid on the packaging materials used to ship the merchandise to the affiliates. At court, the Division conceded that the various external and internal packaging materials at issue constituted wrapping supplies, however, the Division contested the taxpayer’s claimed refund on the basis that the wrapping supplies were for “internal use” and not part of transactions with “another party”. The Tax Court rejected the Division’s argument, finding that the warehouse company and its affiliates were separate legal entities and that there was nothing in the statutory language that would preclude the exemption from applying to transactions between related parties. Further, the court rejected the Division’s substance over form argument, finding that the Division failed to provide sufficient justification for ignoring the taxpayer’s corporate form. Burlington Coat Factory Warehouse Corp. v. Director, Division of Taxation, N.J. Tax Court Docket No. 007007-2013 (December 2, 2014) C. D. Letter Rulings 1. Production Machinery: The Division provided guidance regarding the taxability of the purchase of a machine used to create a series of four foil pouches which contain dietary supplements sold as retail products. These products were only sold in sleeves of four and not in individual pouches. The machine is used to assemble the pouches together, wrap and glue a paper sleeve around the pouches, and imprint a lot code and expiration date onto the paper sleeve. The Division advised that the purchase of the machine is exempt from sales tax as machinery used in the production of tangible property, as provided in N.J.S.A. 54:32B-8.13(a). Letter Ruling 2012-3-SUT (June 22, 2012). 2. Sales of Paper and Plastic Products to Restaurants: The Division issued guidance on the sale of plastic delivery bags, plastic plates, paper plates, and styrofoam plates, cups and bowls to restaurants and other food establishments. The taxpayer at issue was a wholesale supplier of food products to restaurants and other food establishments. The Division advised that these purchases are exempt as non-taxable wrapping supplies because these items are non-returnable and used in the delivery of prepared food to the end consumer. Letter Ruling 2013-2 SUT (September 6, 2013). 3. Long-Term Apartment Rentals: The Division issued guidance regarding long-term apartment rentals for corporate housing. The taxpayer at issue was a corporate housing company. The Division advised that the taxpayer will not be considered to be operating a hotel and thus, does not have to collect sales tax from lessees if the company’s activities are limited to providing furnished apartments for residents on a business-to-business basis and does not open its facility to the public for transient occupancy. The Division also distinguished the taxpayer from a hotel in that the taxpayer does not provide typical hotel services, such as room service, parking, front desk services, conference rooms and 24 hour security. Letter Ruling 2013-3 SUT (September 10, 2013). Administrative Developments 1. Software and Software Services: The Division has adopted amendments to the existing regulations regarding the sales tax treatment of software and related services (e.g., whether software services constitute taxable repairs, maintenance, installation, or servicing). Sollie, Gutowski, & Weyman Reed Smith LLP The proposed regulations have several taxpayer-friendly definitions. For example: (1) limiting taxable installation services to “loading executable files” onto a computer; (2) broadly defining non-taxable modification services to include any service to enhance, improve, or customize software other than installation services or servicing. (3) limiting taxable servicing of software to repairs and maintaining compatibility with other hardware and software products; (4) expanding the definition of custom software to include software developed using prewritten functions and routines; and (5) permitting taxpayers to break out taxable and non-taxable components of software maintenance contracts—even if they were not separately stated on the invoice. See N.J.A.C. 18:2425.1, 25.6, and 25.7 (Amended Effective December 1, 2014). 2. Information Services: New Jersey has adopted regulations concerning information services. The tax does not apply to personal or individual information and the Division’s regulations provide examples distinguishing between information services, and services that provide personal or individual information, as well as services provided by lawyers, physicians, and accountants that require the collection of information but the true object of the transaction is not an information service. N.J.A.C. §18:24-35.1 – 35.5. Even if a taxpayer purchased taxable information services, New Jersey tax should be paid only to the extent that the services were used in New Jersey. Multi-state taxpayers that paid New Jersey tax on the entire purchase price should consider filing a refund claim. 3. Contractor Exemption for Qualified Exempt Entities: The Division issued a technical bulletin clarifying the exemption for contractors engaged in improving, altering, or repairing real property of an exempt entity. When a contractor is engaged in such work and makes purchases of materials, supplies and services used exclusively to fulfill the contract with the exempt organization, those purchases are not subject to tax. The exemption applies if the contractor is engaged in such work for a: tax-exempt entity (nonprofit), Urban-Enterprise Zone qualified business, or a qualified housing sponsor. Purchases of construction equipment, office equipment, temporary buildings, and repair services to equipment are still subject to tax. TB-67 (November 1, 2012). 4. Cloud Computing Services: The Division issued a technical bulletin providing guidance on the sales tax ramifications of various cloud computing arrangements and services. Generally, the use of software, platforms and applications via cloud computing resources will not be taxable if there is no delivery of the item to be used. In most instances, purchasers pay to access these resources. As such, these are services that are not enumerated as taxable in the sale and use tax law. In addition, data hosting and webhosting services are not subject to sales tax as well. TB-72 (July 3, 2013). 5. Automated Teller Machines (ATMs): The Division issued a technical advisory memorandum discussing the purchase and installation of ATMs, bank vaults and safe deposit boxes. A free-standing ATM is not considered to be “permanently affixed” to real property. As such, it does not constitute an exempt capital improvement and charges for installation are subject to tax. An ATM that is installed in the wall is considered to be “permanently affixed” to real property and is thus considered to be an exempt capital improvement. Therefore, installation charges for these ATMs are not subject to tax. The Division also provided that bank vaults and safe deposit boxes in a wall or vault and drive-through windows are also considered to be exempt capital improvements. Sollie, Gutowski, & Weyman Reed Smith LLP Installation charges for these items are not subject to sales tax. TAM 2013-1 (July 7, 2013). 6. Additional Guidance on Information Services: The Division issued additional guidance discussing the taxation of information services. Taxable information services do not include personal or professional services or non-enumerated services in which the service provider may collect or review information to provide the purchaser with the “true object” of the service. Additionally, the publication explains how certain information services are not taxable information services because they provide personal or individual information that is not incorporated into reports, publications or another medium generally provided to paying clients. ANJ-29 (August 1, 2013). 7. Medical Devices: N.J.S.A. 54:32B-8.1 provides an exemption for certain medical supplies and equipment. The Division has proposed new regulation N.J.A.C. 18:24-37 to provide guidance on what types of tangible personal property falls within the sales and use tax medical exemption. Included in the new regulation are definitions of statutory terms such as drug, grooming and hygiene products; and examples of taxable and exempt items. 8. Urban Enterprise Zone Sales and Use Tax Exemptions: The Division has proposed amendments, repeal, and new rules to the UEZ. Most notable are the following: a. Definitions section: substantially expanded to include definitions of certified seller, energy, motor vehicles, natural gas, partial sales tax exemption, qualified business, and utility service. N.J.A.C. 18:24-31.2. b. Examples: numerous examples are proposed to provide clarity to the definitions and requirements such as examples of services used or consumed exclusively within a UEZ (N.J.A.C. 18:24-31.3(b)(2)); examples of transactions that originate within a UEZ that qualifies for the partial sales tax exemption, as well as the timing of payments on orders, and taxability of delivery charges (N.J.A.C. 18:2431.4(d)-(h)). c. Updated to reflect common business practices as a result of changes in technology (email, internet). N.J.A.C. 18:24-31.4(e). d. Section delineating taxable services not eligible for the partial sales tax exemption. N.J.A.C. 18:24-31.5. 9. Charges for Postage: The Division issued updated guidance to sellers of printed advertising materials confirming that sales tax is due on a print and mail vendor’s delivery charges—including postage—for sales of printed advertising materials mailed into New Jersey. However, the Division also clarified that if the customer uses its own postal permit and USPS deducts the postage cost directly from the customer’s account, no tax is due. “Information for Sellers of Printed Advertising Material: Charges for Postage” (December 18, 2014). 10. Nexus: In December, New Jersey issued administrative guidance regarding the affiliate nexus statute passed earlier in 2014. (See II.A.3). The guidance details activities triggering the presumption of nexus for an out-of-state seller receiving referrals from instate independent contractors and/or representatives, as well as requirements the seller must meet to rebut that presumption. Specifically, an out-of-state seller presumed to be Sollie, Gutowski, & Weyman Reed Smith LLP soliciting business in New Jersey through in-state representatives can rebut the presumption by (1) entering into an agreement with the in-state representative that prohibits the in-state representative from engaging in solicitation activities; and (2) obtaining a yearly certification from the in-state representative that the in-state representative does not conduct solicitation activities on behalf of the remote seller. TB76 (December 12, 2014). III. ADDITIONAL ITEMS 1. Alternative Business Calculation Established: New Jersey’s Gross Income Tax is imposed on a taxpayer’s gross income by summing a number of separately stated enumerated categories of income. Until 2012, a taxpayer could not net gains and losses between income categories and there was no provision for any type of loss carryover. This means that a taxpayer with S corporation gain/loss, partnership gain/loss, and sole proprietor gain/loss could not net these gains and losses to arrive at taxable income. The alternative business calculation would allow taxpayer to consolidate gains and losses between business income categories and carryover losses for up to 20 years. A taxpayer would calculate taxable income without the new calculation and with the new calculation. The resulting difference between the two is referred to as the business increment. Beginning in 2012, taxpayers may deduct a percentage of the business increment when arriving at taxable income. The phase in of the percentages is as follows: 10% for tax year 2012; 20% for tax year 2013; 30% for tax year 2014; and 50% for tax year 2016 and thereafter. 2. The End of TEFA: The Transitional Energy Facility Assessment is a tax imposed on electricity bills that first was born as a temporary tax as part of an electric energy deregulation initiative. The Christie administration committed to and budgeted for the continued phase-out of the assessment by the close of 2013. P.L. 2008, c.32. 3. End of Regular Place of Business Requirement Rule: The Division has issued guidance that an unincorporated business entity no longer has to maintain a regular place of business outside of the state to allocate income. This follows the statutory change made to the corporation business tax which eliminated the requirement for incorporated taxpayers. As such, owners and shareholders of unincorporated business entities may complete the Business Allocation Schedule, Form NJ-NR-A to allocate their multi state business income. 4. Scope of Refund Claims for Paid Audit Assessments: In Kinko’s Network, Inc. v. Director, No. A-2261-13T2 (Jan. 31, 2014), the Tax Court ruled that a taxpayer pay an assessment and later file a refund claim to recover that tax paid with respect to any issue raised in the assessment. For this purpose, the court concluded that an issue had been raised by the assessment where the Division’s auditor refused to make an adjustment requested by the taxpayer during the audit. The case is currently on appeal before the Appellate Division. If you are interested in any pleadings or briefs in these cases, e-mail [email protected]. Kyle O. Sollie Partner Reed Smith LLP Three Logan Square 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 Tel: +1 215 851 8852 Tel: +1 415 659 5905 Email: [email protected] Kyle joined Reed Smith in March 2007 and is a member of the firm's State Tax Group. Kyle and his colleagues in Reed Smith's offices in San Francisco, Chicago, Philadelphia and D.C. use the right legal tools at the right time to help their clients pay no more state tax than legally due. Kyle's practice includes state tax appeals, focusing on the states of Pennsylvania, New Jersey, Delaware, and California. For example, he is currently representing one of the taxpayers in the New Jersey throwout litigation Pfizer, Inc., et al v. Division of Taxation, 2008 WL 2357918. His litigated cases also include McNeil-PPC, Inc. v. Commonwealth of Pennsylvania, 834 A.2d 515 (Pa. 2003), First Union National Bank v. Commonwealth, 867 A.2d 711 affirmed, 901 A.2d 981 (Pa. 2006) and Dial Corp. v. Delaware Director of Revenue, C.A. No. 06C-05-014 (Del. Super. 2008). He has also co-authored the amicus briefs filed by the Tax Foundation in DaimlerChrysler Corp. v. Cuno, 126 S.Ct. 1854. More commonly, of course, he leverages the credible threat of successful litigation to negotiate favorable resolutions for taxpayers outside the courtroom and outside of the public light. He has also helped effect regulatory changes through the official and unofficial comment process and he has successfully obtained unpublished policy documents through state-law FOIA claims, appeals, and litigation in Delaware, Pennsylvania, New Jersey, and California. Publications Co-Author, “The BIS Case: A Big Shift in New Jersey’s Unitary Business Rule and the Taxation of Corporate Partners,” J. of Multistate Taxation and Incentives (May 2012) Co-Author, “New Jersey Adopts Expansive, Retroactive Nexus Regs,” State Tax Notes (8/15/11). Co-Author, “Appellate Court Upholds New Jersey Throwout Rule,” J. of Multistate Taxation and Incentives (Feb. 2011) Co-Author, “New Jersey Won’t Appeal Interest Addback,” State Tax Today (Oct. 11, 2010) Co-Author, “Resolving New Jersey Throwout Cases Without Waiting For the Courts’ Ultimate Resolution in Whirlpool and Pfizer,” BNA Multistate Tax Report (Aug. 2010) Co-Author, New Jersey NOL Carryovers: Get Four More Years Despite the Tax Division's Contrary Views, RIA's Journal of MultiState Taxation, Vol. 18, No. 9 (January 2009) Co-Author, Commerce Energy: Does Ohio's Sales and Use Tax, Imposed on Natural Gas, Violate the Commerce Clause?, IPT Income Tax Report (November 2008) Co-Author, Temporary Setback for Taxpayers on Throwout in New Jersey, IPT Income Tax Alert (July 2008) Co-Author, Maryland Comptroller Assesses 'Wolves in Sheep's Clothing' to Generate Revenue, State Tax Notes (Feb. 20, 2008) Co-Author, "Delaware Wins Bank Apportionment Case but Loses Commerce Clause Argument," State Tax Notes (11/16/07) Co-Author, New Jersey Tax Court: "'No Reasonable Cause' for IHC Not to File Returns", State Tax Notes (8/28/07) Co-Author, "Company Files Summary Judgment Brief in New Jersey Throwout Case," State Tax Notes (5/30/07) Co-Author, "Tax Foundation Files Amicus Brief in Tax Nexus Case," State Tax Notes (5/8/07) Co-Author, "Refund Deadline Looms for New Jersey Alternative Minimum Assessment," State Tax Notes (3/27/07) Co-Author, "Throwout and FIN 48 Pose Multiple Headaches for Passive Investment Companies in New Jersey," BNA State Tax Management Portfolio, 2007 No. 5 (1/19/07) Experience 2007—Reed Smith 1996—Dechert Education 1996—J.D., cum laude, Villanova University School of Law Member, Villanova Law Review 1993—B.A., magna cum laude, Temple University Professional Admissions / Qualifications Pennsylvania New Jersey Court Admissions U.S. Supreme Court Professional Affiliations Certified member of the Institute for Professionals in Taxation, serving as the Vice-Chair of its Legal Committee - Sales Tax Chair of the institute's 2006 Sales & Use Tax Symposium Committee. Member of the editorial board of RIA's Journal of MultiState Taxation and Incentives Focuses on editing articles for that publication related to New Jersey developments Notable Quotes "New Jersey's 'Throwout Rule' Faces Repeal as Governor, Legislature Ramp Up Efforts to Stimulate State's Economy", BNA Daily Tax Report (Nov. 19, 2008) "N.J. Tax Court Rules on Apportionment Issues," CCH State Income Tax Alert, Vol. XVII, No. 12 (July 15, 2008) "Pennsylvania Court Case Could Change the tax rules for Bank M&A," American Banker (June 24, 2008) "U.S. Supreme Court Upholds Kentucky Tax Law Giving Interest Exemption to In-State Bonds", BNA Daily Tax Report (May 23, 2008) "U.S. Supreme Court Upholds Kentucky Municipal Bond Tax Exemption," State Tax Notes (May 20, 2008) "Supreme Court Upholds State Municipal Bond Exemption", Law.com (May 20, 2008) "New Jersey's Throwout Rule: The Division of Taxation Singles Out General Engines for Full Summary Judgment", BNA Daily Tax Report (May 16, 2008) "New Jersey Tax Court Oral Arguments in Throwout Case", State Tax Notes (April 3, 2008) "Oral Argument Held in New Jersey Throwout Litigation", CCH State Income Tax Alert, Vol. XVII, No. 6 (April 1, 2008) "Supreme Court Rebuffs Ohio Tax Break Challenge," The Wall Street Journal (May 2006) "PA Business Privilege Tax Penalizes Manufacturers," The Philadelphia Inquirer (June 2006) "Federally Chartered Banks Protected by Commerce Clause," CCH State Income Tax Alert, Vol. XVI, No. 20 "New Jersey Tax Court Finds IRC § 338(h)(10) Transaction Creates Non-Operational Income," CCH State Income Tax Alert, Vol. XVI, No. 15 (9/1/07) "New Jersey Throwout Cases Progress," CCH State Income Tax Alert, Vol. XVI, No. 10 (6/1/07) "Lanco and MBNA File Petitions for Certiorari With U.S. Supreme Court," CCH State Income Tax Alert, Vol. XVI No. 6 (4/1/07) "Deadline for New Jersey Refund Claims Nears," CCH State Income Tax Alert, Vol. XVI No. 6 (4/1/07) "New Jersey Plaintiffs Attempt to Throw Out Throwout," State Tax Notes (2/13/07) David J. Gutowski Partner Reed Smith LLP Three Logan Square 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 Tel: +1 215 851 8874 ▪ +1 609 524 2028 Email: [email protected] David is a partner in Reed Smith's State Tax Group. His practice involves multi-state sales and use and corporate tax appeals, including representing clients in state tax litigation before administrative boards and courts in various jurisdictions. David is a New Jersey registered lobbyist and has submitted comments on behalf of COST concerning New Jersey regulations. David is a frequent speaker on state and local tax issues. He has spoken on various state tax issues for the Equipment Leasing Association, Strafford Legal Teleconferences, the Institute of Professionals in Taxation, and COST. David is a regular contributor to such publications as the Journal of Multistate Taxation, Tax Analyst's State Tax Notes, and BNA's Multistate Tax Report. He is a member of the New Jersey Chamber of Commerce's Taxation Committee and a member of the Pennsylvania and New Jersey Bars. David is a graduate of Franklin and Marshall College (B.A., 1995) and Temple University School of Law (J.D., cum laude, 2000). Articles and Publications Quoted, “Settlement in New Jersey Nexus Case Leaves Unanswered Questions,” State Tax Notes (3/12/15). Quoted, “New Jersey Tax Court Order Could Spell Trouble for Throwout Rule,” State Tax Notes (9/16/13). Quoted, “New Jersey Division of Taxation Proceeding With Market-Based Sourcing,” State Tax Notes (4/30/13). Quoted, “New Jersey Alternative Minimum Assessment Looms Over P.L. 86-272 Companies,” State Tax Notes (10/15/12). Co-Author, “The BIS Case: A Big Shift in New Jersey’s Unitary Business Rule and the Taxation of Corporate Partners,” J. of Multistate Taxation and Incentives (May 2012) Quoted, “Broader Implications of New Jersey's Interpretation of Throwout Opinion,” State Tax Notes (10/11/11). Quoted, “New Jersey's Voluntary Disclosure Initiative for Media Companies,” State Tax Notes (8/29/11). Co-Author, “New Jersey Adopts Expansive, Retroactive Nexus Regs,” State Tax Notes (8/15/11). Quoted, “New Jersey's Throwout Rule Continues to Throw Punches,” State Tax Notes (8/15/11). Quoted, “Navigating New Jersey's New Business Tax Structure,” State Tax Notes (5/16/11). Author, “COST Comments on New Jersey Financial Services Nexus Regulation,” State Tax Today (Apr. 7, 2011) Co-Author, “Appellate Court Upholds New Jersey Throwout Rule,” J. of Multistate Taxation and Incentives (Feb. 2011) Co-Author, “New Jersey Won’t Appeal Interest Addback,” State Tax Today (Oct. 11, 2010) Co-Author, “Resolving New Jersey Throwout Cases Without Waiting For the Courts’ Ultimate Resolution in Whirlpool and Pfizer,” BNA Multistate Tax Report (Aug. 2010) Co-Author, “Regulation of State Lobbying Activities: Traps for the Unwary,” State Tax Today (9/14/2009) Quoted, “New Jersey Court Rules Related Party Interest Properly Computed,” CCH State Income Tax Alert, Vol. XVIII, No. 13 (8/1/09) Co-Author, “New Jersey Tax Court Denies Apportionment, Provides Guidance on Equitable Relief Provisions,” State Tax Today (5/28/2009) Co-Author, “New Jersey NOL Carryovers,” J. of Multistate Taxation and Incentives (Jan. 2009) Co-Author, “New Jersey Sidesteps Quill’s Physical-Presence Requirement,” J. of Multistate Taxation and Incentives (Summer 2008) Co-Author, “New Jersey Throwout: General Engines Singled Out for Full Summary Judgment,” BNA Multistate Tax Report (Spring 2008) Co-Author, “New Jersey to Gather and Publish Information About Corporations Receiving Subsidies,” J. of Multistate Taxation and Incentives (Spring 2008) Co-Author, “ Company Files Opposition Motion in New Jersey Throwout Case,” State Tax Today (3/17/08) Quoted, “Computation of Trucking Company's Apportionment Formula Affirmed” CCH State Income Tax Alert, Vol. XVII, No. 1 (1/15/08) Quoted, “Pennsylvania Supreme Court Affirms Transportation Apportionment Decision,” State Tax Today (1/11/08) Quoted, “New Jersey Tax Court Finds IRC § 338(h)(10) Transaction Creates Non-Operational Income,” CCH State Income Tax Alert, Vol. XVI, No. 15 (9/1/07) Co-Author, New Jersey Tax Court: “'No Reasonable Cause' for IHC Not to File Returns,” State Tax Notes (8/28/07) Quoted, “New Jersey Throwout Cases Progress,” CCH State Income Tax Alert, Vol. XVI, No. 10 (6/1/07) Co-Author, “Company Files Summary Judgment Brief in New Jersey Throwout Case,” State Tax Today (5/30/07) Quoted, “Deadline for New Jersey Refund Claims Nears,” CCH Income Tax Alert, Vol. XVI, No. 6 (4/1/07) Co-Author, “Refund Deadline Looms for New Jersey Alternative Minimum Assessment,” State Tax Notes (3/27/07) Quoted, “FIN 48 requirements create problems for state tax departments and professionals,” CCH Income Tax Alert, Vol. XVI, No. 4 (3/1/07) Quoted, “New Jersey Plaintiffs Attempt to Throw Out Throwout,” State Tax Notes (2/13/07) Co-Author, “Throwout and FIN 48 Pose Multiple Headaches for Passive Investment Companies in New Jersey,” BNA Multistate Tax Report, 2007 No. 5 (1/19/07) Quoted, “Taxpayers challenge constitutionality and fairness of New Jersey's throwout rule,” CCH Income Tax Alert, Vol. XVI, No. 1 (1/15/07) Co-Author, “Partnership Factor Flow-Through: New Jersey Takes an Unusual Approach,” J. of Multistate Taxation and Incentives, Vol. 15, No. 4 (July 2005) Experience 2007—Reed Smith 2000—Dechert Education 2000— J.D., cum laude, Temple University School of Law Member, Villanova Law Review 1995— B.A., Franklin and Marshall College Court Admissions State Supreme Court - New Jersey State Supreme Court - Pennsylvania Professional Affiliations Member of the New Jersey Chamber of Commerce Taxation Committee Member of the New Jersey Business and Industry Association Taxation Committee 2011 and 2012 New Jersey Super Lawyers Rising Star Robert E. Weyman Associate Reed Smith LLP Three Logan Square 1717 Arch Street, Suite 3100 Philadelphia, PA 19103 T: +1 215 851 8160 F: +1 215 851 1420 Email:[email protected] Rob is a senior associate in the State Tax Group. Rob assists clients with income, sales, and gross receipts tax issues around the country. His practice includes state tax return position evaluation, audit defense, administrative appeals, and litigation. Rob co-leads Reed Smith’s growing Massachusetts state tax practice, which represents taxpayers on a widerange of Massachusetts income and sales tax issues at audit, through all administrative appeal levels, and at the Appellate Tax Board. Rob is also a member of the Associated Industries of Massachusetts Tax Committee. Rob is a frequent writer and speaker on a wide range of state tax issues, and has presented at COST, TEI and other industry conferences. Rob co-authors Massachusetts SALT, Reed Smith’s Massachusetts state tax blog. Publications "Governor Baker Names Mark Nunnelly New Commissioner of Revenue," Massachusetts SALT, 26 March 2015 Co-Author(s): Brent K. Beissel "Massachusetts Tax Developments - A Reed Smith Quarterly Update," Reed Smith Client Alerts, 6 March 2015 "A Quick Overview of Substantive Changes in Final Massachusetts Market Sourcing Regulation 830 CMR 63.38.1—From 10/30/14 Draft to Final," Massachusetts SALT, 5 January 2015 Co-Author(s): Michael A. Jacobs "Massachusetts Promulgates Final Market Sourcing Regulation," Massachusetts SALT, 2 January 2015 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "AIM Proposes Improvements to Tax Rules," AIMBlog, 19 December 2014 Co-Author(s): Michael A. Jacobs "Interstate Truckers Beware—Massachusetts Aggressive Use Tax Policy on Vehicles Purchased Out-of-State Upheld by ATB in Regency Transportation Case," Massachusetts SALT, 11 December 2014 Co-Author(s): Michael A. Jacobs "Massachusetts Market Sourcing Update: Report from Public Hearing on Market Sourcing and Special Industry Apportionment Regulations," Massachusetts SALT, 4 December 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "N.J. Sales Tax—New Software Regulations Adopted," Reed Smith Client Alerts, 26 November 2014 Co-Author(s): David J. Gutowski "ATB Upholds Single-Factor Apportionment for Manufacturer," Massachusetts SALT, 21 November 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Taxpayers Foundation Tax Conference Report," Massachusetts SALT, 5 November 2014 "Massachusetts Releases Second Draft of Market Sourcing Regulations," Massachusetts SALT, 30 October 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "ATB rules that orthopedic braces sold by orthopedic surgeon are exempt from sales and use tax.," Massachusetts SALT, 27 October 2014 Co-Author(s): Brent K. Beissel "Massachusetts Audits and Appeals Update—Transfer Pricing and Embedded Royalties," Massachusetts SALT, 27 October 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Tax Developments - A Reed Smith Quarterly Update (3rd Quarter 2014)," Reed Smith Client Alerts, 14 October 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Supreme Judicial Court hears argument in First Marblehead Case," Massachusetts SALT, 7 October 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Council on State Taxation 50 State Tax Development Summary – Massachusetts," Council On State Taxation (COST), Fall 2014 Co-Author(s): Michael A. Jacobs "Massachusetts House Budget Would Include Tax Amnesty Program For 2015 Fiscal Year," Massachusetts SALT, 30 April 2014 Co-Author(s): Brent K. Beissel "Are early termination fees charges for “telecommunications services” in Massachusetts?," Massachusetts SALT, 24 April 2014 Co-Author(s): Michael A. Jacobs "Commonwealth Faces Tough Questions from Appeals Court Justices In Sham Transaction Case," Massachusetts SALT, 18 April 2014 Co-Author(s): Michael A. Jacobs "NJ Sales Tax - New Software Regulations to be Released Monday," Reed Smith Client Alerts, 18 April 2014 Co-Author(s): David J. Gutowski "Corporate members of LLC can qualify as mutual fund service corporations," Massachusetts SALT, 17 April 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Department Extends Comment Period for Proposed Market Sourcing Regulations," Massachusetts SALT, 17 April 2014 Co-Author(s): Brent K. Beissel "Council on State Taxation 50 State Tax Development Summary – Massachusetts," Council On State Taxation (COST), Spring 2014 Co-Author(s): Michael A. Jacobs "Massachusetts Releases Proposed Market Sourcing and Throwout Regulations, What Does it Mean for You?," Massachusetts SALT, 25 March 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Tax Developments - A Reed Smith Quarterly Update (4th Quarter 2013)," Reed Smith Client Alert, 11 February 2014 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Tax Regulation Changes on the Way—Department of Revenue lays out plans for amended and new regulations for 2014," Massachusetts SALT, 21 January 2014 Co-Author(s): Michael A. Jacobs "Massachusetts Department of Revenue posts audit manual," Massachusetts SALT, 13 December 2013 Co-Author(s): Michael A. Jacobs "Reminder for Taxpayers to File Refunds for the Defunct Massachusetts “Tech Tax”," Massachusetts SALT, 25 November 2013 Co-Author(s): Brent K. Beissel "Welcome to Reed Smith’s Massachusetts SALT Blog," Massachusetts SALT, 25 November 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts DOR Announces Expanded, Permanent Tax Mediation Program," Massachusetts SALT, 25 November 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Tax Developments - A Reed Smith Quarterly Update (3rd Quarter 2013)," Reed Smith Client Alert, 16 October 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Council on State Taxation 50 State Tax Development Summary – Massachusetts," Council On State Taxation (COST), Fall 2013 Co-Author(s): Michael A. Jacobs "Massachusetts Delays Reporting for Software Services Tax; Repeal Imminent?," Reed Smith Client Alert, 16 September 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Rules Against Taxpayer on Treatment of Intercompany Debt—Again," Reed Smith Client Alert, 6 September 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Quarterly Update - A Reed Smith Quarterly Update (2nd Quarter 2013)," Reed Smith Client Alert, 16 July 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Department of Revenue and Appellate Tax Board Look to Expand Tax Dispute Mediation Programs," Reed Smith Client Alert, 21 June 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Massachusetts Tax Developments - A Reed Smith Quarterly Update (1st Quarter 2013)," Reed Smith Client Alert, 25 April 2013 Co-Author(s): Michael A. Jacobs, Brent K. Beissel "Software Vendor Challenges Massachusetts’ Restrictive Policy on Multiple Points of Use Certificates," Reed Smith Client Alert, 12 April 2013 Co-Author(s): Michael A. Jacobs "Reed Smith Massachusetts Quarterly Update," Reed Smith Client Alert, 4th Quarter 2012 Co-Author(s): Michael A. Jacobs "Title Transfer Not Enough to Establish Resale in Massachusetts," Reed Smith Client Alerts, 13 November 2009 Co-Author(s): Michael A. Jacobs "100 Days in the Making—Highlights of Pennsylvania's 2009-2010 Budget," Reed Smith Client Alerts, 15 October 2009 Co-Author(s): Michael A. Jacobs "Massachusetts Supreme Judicial Court Provides Relief to Retailers – No Massachusetts UseTax Collection Obligation for Over-The-Counter Sales Occurring ," Reed Smith Client Alerts, 26 August 2009 Co-Author(s): Michael A. Jacobs "Massachusetts Supreme Judicial Court Upholds Economic Nexus in Geoffrey and Capital One Decisions," Reed Smith Client Alerts, 13 January 2009 Co-Author(s): Michael A. Jacobs Co-Author(s): Michael A. Jacobs, Brent K. Beissel, Gordon Yu Speaking Engagements "Transfer Pricing in the State Arena," Tax Executives Institute, Inc., Malvern, Pennsylvania, 25 February 2015 "Over Seventy Pages; What Do You Need to Know? Massachusetts Releases Final Market Sourcing and Throwout Regulations," Reed Smith Massachusetts Tax Teleseminar, 21 January 2015 "Agency Settlement Bureaus: Using Them Effectively (Using California, Massachusetts & Pennsylvania as a Case Study)," COST Pacific Northwest Regional State Tax Seminar, Concord, California, 24 June 2014 "Transfer Pricing Issues in the State Arena," "Elective Apportionment Under the MTC and State Action," Tax Executives Institute, Inc., Studio City, California, 16 May 2014 "Massachusetts Releases Proposed Market Sourcing and Throwout Regulations, What Does it Mean for You?," Reed Smith Massachusetts Tax Teleseminar, 10 April 2014 "Massachusetts Apportionment Update," Reed Smith Massachusetts Tax Teleseminar, 21 August 2013 "Massachusetts Sales Tax on Software and Related Services," Reed Smith Massachusetts Tax Teleseminar, 7 August 2013 Employment History 2007 - Reed Smith Notable Quotes "Massachusetts DOR Releases Final Market-Based Sourcing Regs”, Tax Analysts, 6 January 2015 "Massachusetts DOR Revises Draft of Market-Based Sourcing Reg”, Tax Analysts, 3 November 2014 "Coming Clean: Voluntary Disclosure Agreements Carry Risk and Reward”, Tax Analysts, 4 August 2014 "Massachusetts Market-Based Sourcing Regs May Create Difficulties for Taxpayers, Practitioners Say”, Tax Analysts, 27 March 2014 PENNSYLVANIA STATE DEVELOPMENTS Lee A. Zoeller Reed Smith LLP Three Logan Square Suite 3100 1717 Arch Street Philadelphia, PA 19103 Phone: 215-851-8850 [email protected] Frank J. Gallo Christine M. Hanhausen Reed Smith LLP Reed Smith LLP Three Logan Square Three Logan Square Suite 3100 Suite 3100 1717 Arch Street 1717 Arch Street Philadelphia, PA 19103 Philadelphia, PA 19103 Phone: 215-851-8860 Phone: 215-851-8865 [email protected] [email protected] I. INCOME/FRANCHISE TAXES A. Legislative Developments 1. Act 52 of 2013: In 2013, the General Assembly passed, and then-Governor Tom Corbett signed into law, Act 52. Act 52 includes the following: Single Sales Factor: For taxable years beginning on or after December 31, 2012, all business income shall be apportioned using a single sales factor. Phase out of the Capital Stock and Foreign Franchise Taxes: The capital stock and foreign franchise taxes now phase-out beginning in 2016. Increase Cap on Net Loss Deductions: Act 52 slightly relaxed the limitations on the amount of NOL deductions a taxpayer can utilize in a particular tax year. For tax years beginning in 2014, the cap is the greater of $4 million or 25% of taxable income. For tax years beginning after 2014, the cap is the greater of $5 million or 30% of taxable income. Related-Party Addback: For tax years beginning after December 31, 2014, Act 52 requires taxpayers to add back related-party intangible expenses and certain interest expenses, unless an exception applies. The addback applies to related-party interest expenses directly related to intangible expenses. The addback provision includes a credit for tax paid by affiliated entities. The exceptions include: Principal Purpose and Arm’s Length Exception: Transactions that (1) do not have as the principal purpose the avoidance of Pennsylvania corporate income tax, and (2) that are done at arm’s length; Income Tax Treaty Exception: Transactions with a foreign affiliate in a nation that has an income tax treaty with the United States; and Conduit Exemption: Transactions where an affiliate paid a non-affiliate for the intangible or interest expense, and is equal to or less than the taxpayer's proportional share of the transaction. Market-Based Sourcing of Services. Act 52 adds market-based sourcing for sales of services; sales, leases, or rentals of real property; and rentals, leases, and licenses of tangible personal property for tax years beginning on or after January 1, 2014. Pennsylvania’s new market-sourcing rules apply to receipts from (i) services; (ii) sales, leases and rentals of real property; and (iii) rentals, leases and licenses of tangible personal property. (These new rules are effective for tax years beginning on or after January 1, 2014. While other states have completely shifted to market-based sourcing for receipts from all transactions other than sales of tangible personal property, Pennsylvania’s shift is only partial. Pennsylvania has retained the cost-ofperformance rule for many types of receipts. In addition, the Department published guidelines regarding the new market-sourcing rules. See below Section I.C.1. US_ACTIVE-121608368.1 Reed Smith LLP Sales of Services: Before Act 52, sales of services were sourced under the catch-all rule for sales other than tangible personal property. This meant that services were sourced to Pennsylvania only if more income-producing activity was performed in Pennsylvania than in any other state, based on cost of performance. Under Act 52’s new market-based sourcing regime, the default rule is that services are sourced to where the service is delivered. If the delivery location cannot be determined, then the services are sourced to where the customer places the order for the services. If the location from which the services were ordered cannot be determined, then the services are sourced to the customer’s billing address. Sales, Leases, and Rentals of Real Property: Before Act 52, sales of real property were sourced under the catch-all rule. Under Act 52, the new rule is that these receipts are sourced to Pennsylvania if the property is located in Pennsylvania. If the real property is located both inside and outside of Pennsylvania, the portion sourced to Pennsylvania is based on the “percentage of original cost of the real property” in Pennsylvania. This is a change from the often overlooked prior statutory rule that sourced rental income from any property—including real property—based on cost of performance. Rentals, Leases, and Licenses of Tangible Personal Property: Before Act 52, rentals, leases, and licenses of tangible personal property were sourced under the catch-all rule. Under Act 52, the new rule is that these receipts are sourced to Pennsylvania if the customer “first obtained possession” of the property in Pennsylvania. If the property is subsequently taken out of Pennsylvania, taxpayers are permitted to use a “reasonably determined estimate” to source only a portion of the sale to Pennsylvania and the remainder outside Pennsylvania. Again, this is a change from the oftenoverlooked prior statutory rule that sources rental income from any property— including tangible property—based on cost of performance. Sales of Intangibles: Under Act 52, sales of intangibles continue to be sourced according to cost of performance. Following the Department’s policy of interpreting income-producing activity to mean the location where the customer received the benefit, taxpayers can continue to elect whether to follow the statute (cost-based sourcing) or the Department’s policy (market-based sourcing) in sourcing intangibles. B. Judicial Developments 1. Can an Amended Return be Filed to Claim a Corporate Tax Refund? On February 11, the Commonwealth Court, en banc, heard oral argument in a case in which the sole issue before the court was a procedural one: whether an amended return can be used to claim a corporate tax refund, or whether a corporate tax refund must be claimed by filing the Department of Revenue’s refund claim form with the Department’s Board of Appeals. There is no doubt that the taxpayer in this case timely filed an amended return, but the Department’s position is that an amended return resulting in a refund is not the same as a “petition for refund.” The Department argues that it is not required to take any action on an amended return, and any action (or inaction) in response to an amended return cannot be appealed. Moreover, the Department has also ignored its own regulation—and, in this litigation, did not tell the court about the regulation—that allows a taxpayer time to cure any deficiency in the form of a refund claim. The taxpayer in this case filed an amended return within the three-year statute of limitations for a refund claim. The taxpayer and the Department corresponded back-andforth about the changes reflected on the amended return during the three-year period for claiming a refund. Then, after that three-year period had expired, the Department notified the taxpayer that the Department did not agree with the amended return. According to the -2- Reed Smith LLP Department, the taxpayer was then unable to file a refund petition because the statute of limitations was closed. In practice, the Department seems to routinely accept amended returns that increase tax, while often not acting on amended returns that decrease tax. For the taxpayer in the case that was argued February 11, it will now be up to the court to decide whether the amended return at issue was sufficient to preserve its right to a refund. In should be noted that in many situations, an amended return will satisfy all the relevant requirements for a refund petition under the Department’s regulation, 61 Pa. Code § 7.14. So if you find yourself in a situation similar to the taxpayer in this litigation, you may still be able to argue that you timely filed a refund petition. That said, if you are still within the three-year limitations period, the safest bet is to file the Department’s refund claim form. C. Administrative Developments 1. Department of Revenue Issues Market-Sourcing Guidance: The Pennsylvania Department of Revenue has issued guidance on Pennsylvania’s new market-based sales-factor sourcing statute. The Department did not promulgate a formal regulation, but instead issued an “Information Notice.” We note that the Information Notice is mere “Revenue Information.” The Department’s own regulations downplay the importance of a notice like this because, under the regulations, Revenue Information is “material … issued for informational purposes only and should not be relied upon.” Nonetheless, the notice is a useful tool to understand the Department’s policies on salesfactor sourcing, even though it does not carry the same weight as a law (or a regulation, for that matter). Under the statute, therefore, taxpayers continue to have much flexibility in sourcing of receipts from services and intangibles. For example, interest receipts and receipts from licensing or sales of intangibles are clearly not covered by the market-sourcing rules. In addition, other classes of receipts fall into a gray area between receipts from services and those from intangibles. We believe that, if it benefits your company, you can take the position that the following receipts continue to be sourced on a cost-of-performance basis: - Finance leases, treated as such for GAAP purposes - Franchise fees - Data processing, telecommunications, and information services D. Trends and Outlook for 2015–2016 1. Mandatory Combined Reporting: Gov. Wolf proposed mandatory unitary combined reporting. This proposal is not new to Pennsylvania. In fact, combined reporting was a major recommendation of Gov. Rendell’s Business Tax Reform Commission in 2004 (and Wolf was a member of that commission). Various combined reporting proposals have circulated in the House during recent years, but none of the proposals had enough support to move forward. 2. Reduce Corporate Net Income Tax Rat: Gov. Wolf proposed to reduce the corporate net income tax rate from 9.99% to 4.99% by 2018. This proposal is to increase the appeal of combined reporting; however, it is not clear that combined reporting has enough support in the legislature. 3. NOL Cap: While tax reform measures in recent years have increased the cap on the net loss deduction, see above Section I.A.1, Gov. Wolf proposed to undo those changes and -3- Reed Smith LLP reduce the cap back to $3 million, or 12.5% of income. Any revenue generated by the cap would ultimately have to be refunded to taxpayers if a court agrees that the flat-dollar cap constitutes a uniformity violation. Wolf’s team justifies this proposal because “only approximately 290” corporations would be affected by the reduced cap. 4. Department of Revenue Targeting Royalty-Earning “IP Holding Companies”: The Department continues to occasionally assert sham transaction/economic substance arguments to disallow royalty deductions for royalty payments to affiliates for intellectual property rights. The Department is doing this in both the corporate net income tax and franchise tax context. In fact, the Board of Finance and Revenue recently issued a decision upholding the Department’s disallowance of royalty deductions from federal taxable income (for income tax purposes) and book income (for franchise tax purposes). According to the Board, “[t]he royalty payments were illegitimate and lacked economic significance because the transactions served no economic purpose and were engaged in for the sole purpose of evading the payment of Pennsylvania corporate taxes.” Taxpayers continue to appeal these issues to Commonwealth Court and those able to demonstrate that their IP Holding Companies had economic substance have been able to enter into favorable negotiated settlements. It’s unclear whether the Department will continue to rely on sham transaction and economic substance arguments in attacking IP Holding Companies going-forward now that Pennsylvania’s new royalty addback statute is effective (for corporate net income tax purposes only) for tax years beginning on or after January 1, 2015. That new statute also codifies the Department’s “sham transaction” authority. 5. Market Sourcing vs. Cost of Performance: For receipt factor apportionment purposes prior to 2014, Pennsylvania sources receipts from sales other than sales of tangible personal property based on cost of performance. Nonetheless, the Department has, at times, taken the position that market sourcing is necessary to fairly reflect the taxpayer’s business activity in the State. Some taxpayers have also taken this position on their returns or in refund claims. Recently a few costs of performance cases have settled in Pennsylvania. Taxpayers that were assessed by the Department using a market-based approach received a significant settlement percentage. Taxpayers that took the market sourcing position themselves also received meaningful relief at settlement. The new market-sourcing statute, which leaves plenty of room for interpretation as written, continues to source sales of intangibles according to cost of performance. Accordingly, the Department may continue to interpret this provision using a marketbased approach where beneficial to the Commonwealth. II. SALES AND USE TAXES A. Judicial Developments 1. Sales Tax Class Action Suits—Are They Allowed? Two class action suits against retailers are pending in courts in Pennsylvania. In both cases, the plaintiffs allege that the retailer collected sales tax on the full price of items when customers used discount coupons. The plaintiffs are seeking refunds of the tax paid on the discounted portion of the purchases, along with treble damages and attorneys’ fees. This is not the first time a plaintiff has brought a sales tax class action suit in Pennsylvania courts. The previous attempts, however, have been unsuccessful. For example, in 2011, in the case of Stoloff v. Neiman Marcus Group, Inc., the Pennsylvania -4- Reed Smith LLP Superior Court held that "primary jurisdiction over the tax-refund claims belong to the [Revenue] Department.” The pending cases have bounced back and forth between federal and state courts in Pennsylvania. At this time, whether these cases will face the same fate as the Neiman Marcus case is unclear. B. Administrative Developments 1. Revised Mining Exemption Guidance: On September 22, 2014, the Department of Revenue issued an information notice on the sales and use tax exemption for tangible personal property and services predominantly used directly in mining activities. Information Notice Sales and Use Tax 2014-02: Natural Gas Mining (9/22/14). Notably, the Department’s new guidance specifically lists items as taxable under the theory that they fall within the “vehicles required to be registered” clause. Per the Department, this includes vehicles registered under the International Registration Plan and truck chassis to which a drilling unit or service rig is affixed. However, there are cases pending at Commonwealth Court currently that specifically address the taxability of these items. That is, the Department’s new guidance might go beyond the statutory reach. C. Trends and Outlook for 2015–2016 1. Expand Reach of Sales and Use Tax and Increase the Rate: Gov. Wolf proposed increasing the state sales and use tax rates to 6.6% and increasing the base to include services not currently taxable and eliminating 45 exemptions currently in place. Wolf’s budget analysis estimates a $1.5 billion revenue increase from these changes. Las session, Senate Bill 76, a school district property tax reform proposal that also sought to overall the sales and use tax to replace the property tax funds, circulated both the House and Senate and was at the forefront of the debate. However, SB 76 did not have enough support in the legislature. In addition, business groups, including the Council on State Taxation (COST), expressed concern about SB 76 because it would effectively shift much of the tax burden from individuals to businesses. Senate Bill 76 would also tax an array of services that have historically gone untaxed (e.g., legal and accounting services). Given the history of SB 76, we can expect a lot of debate surrounding any major reform to the sales and use tax base. 2. Treatment of Cloud Computing: Through a letter ruling, the Department of Revenue changed its taxation of cloud computing from location of server to location of end-user. Letter Ruling No. SUT-12-001 (May 31, 2012). The taxpayer in the ruling used cloud computing in two ways. First, the taxpayer purchased and installed software on remote servers that was accessed by its employees through the cloud. The employees were not charged for using the software. Second, the taxpayer installed software on remote servers and charged customers a fee to access the software. The Department determined that, as a result of recent case law and advances in technology, a fee paid for accessing otherwise taxable software housed on a server is subject to sales and use tax when the user is located in Pennsylvania. The Department focused on the fact that a user accessing remote software exercises power and control over the software. Similarly, the letter ruling states that if the software is located on a server in -5- Reed Smith LLP Pennsylvania, but all end users are outside of the Commonwealth, no tax is due. If the billing address for the software is a Pennsylvania address, it is presumed that all users are located in the Commonwealth. To rebut this presumption, the taxpayer must identify the percentage of users in Pennsylvania by completing an exemption certificate. The Department continues to modify its proof requirements for taxpayers seeking to establish the number of end users located outside the Commonwealth. Additionally, the Department recently asserted that all unassigned licenses will be considered Pennsylvania receipts. The Department’s treatment will likely continue to evolve as various appeals make their way through the administrative process and into Commonwealth Court. III. PROPERTY TAXES A. Judicial Developments 1. Senior Citizens Property Tax and Rent Rebates Assistance Act invalidated: In Muscarella v. Commonwealth, the Commonwealth attempted to argue that the Department of Revenue’s validly-promulgated regulation should be disregarded. The Commonwealth Court rejected this argument. The Commonwealth Documents Law requires that the notice-and-comment process cannot be ignored when the Commonwealth (or one of its agencies) acts in a manner that amends or establishes a regulation. Muscarella involved a challenge to Department of Revenue’s regulations interpreting the property tax rebate available to senior citizens. The Department’s regulations permit a decedent’s estate to claim the rebate if the decedent would have otherwise qualified under the statute, but only if the decedent survived the entirety of the calendar year in which the taxes were paid. The taxpayer in this case represented a class of estates that could have claimed the rebate but for the fact that the decedent did not survive the entirety of the calendar year in which the tax was paid. The taxpayer argued that the Department’s regulations violate state and federal due process and equal protection principles because they treated estates of decedents who survived the entire year more favorably than estates of decedents who did not. The court agreed with the taxpayer and declared the regulations invalid insofar as they limited the ability of an estate to claim a rebate if the decedent did not live for the entire year in which the tax was paid. This meant that any estate could claim the rebate so long as the statutory requirements were met. The Commonwealth, having lost on the constitutional issues, then turned to arguing that the Department’s regulations should be disregarded entirely because the statute is clear on its face that no estates may claim the rebate. Not only did the court disagree with the Commonwealth on this point, but the court also noted that the Commonwealth Documents Law precludes the Commonwealth from attempting to amend or void the Department’s properly promulgated regulations. The court made it clear that the Department would have to follow formal notice-and-comment procedures to make changes to the regulations. Muscarella v. Commonwealth, 87 A.3d 966 (Pa. Commw. 2014). 2. Eligibility for Purely Public Charity Exemption: A few recent cases may spur more challenges to the HUP status of not-for-profit entities of traditionally tax exempt organizations. Hospitals: The City of Pittsburgh sued University of Pittsburgh Medical Center (UPMC) for back payroll taxes, alleging that UPMC did not qualify as a “purely public charity” and, therefore, was not exempt from the payroll tax. UPMC argued that it did not have any employees, so it could not owe payroll taxes—the medical -6- Reed Smith LLP center’s staff members were employees of UPMC’s subsidiaries. On June 14, the Allegheny County Court of Common Pleas issued a ruling in favor of UPMC. The court did not, however, address the issue of whether UPMC was a purely public charity. The City could have filed a new claim against the UPMC subsidiaries, but the City instead chose to drop the case. No. GD 13-005115, City of Pittsburgh v. University of Pittsburgh Medical Center, (pending, Court of Common Pleas of Allegheny County); Civil Action No. 13-565, 2013 WL 4010990 (W.D. Pa. August 6, 2013). Universities: In January 2014, the Monroe County Court of Common Pleas stripped a not-for-profit student housing corporation affiliated with East Stroudsburg University (“ESU”) of its tax exempt status. ESU formed the not-for-profit corporation, University Properties, Inc. (“UPI”), to construct, operate, and maintain student housing for ESU. UPI received a tax exempt status for the 2013 tax year, but the East Stroudsburg School District appealed that exemption. At trial, the parties conceded that UPI satisfied four of the five prongs of the HUP test, the constitutional test for whether an organization is exempt from tax as a purely public charity. The School District, however, contested that UPI did not donate or render “gratuitously a substantial portion of its services.” The trial court agreed. Relying on an unreported opinion of the Commonwealth Court, CHF-Kutztown LLC v. Berks County Board of Assessment Appeals, the trial court found that neither the provision of free services to resident advisors nor the donation of surplus revenue to ESU demonstrated that UPI donated or rendered gratuitously a substantial portion of its services. Rather, the trial court held that the focus of this prong should be on whether the housing provided subsidies to ESU students who did not have the financial resources to pay for housing. Because UPI failed to produce any quantifiable evidence on this point, the trial court concluded that UPI did not satisfy the HUP test and stripped UPI of its not-for-profit standing. East Stroudsburg Area School District v. Monroe County Board of Assessment Appeals. Constitutional Amendment Proposal: An amendment to the Pennsylvania Constitution has been proposed to clarify that the General Assembly has the authority to determine what is a “purely public charity.” The proposed amendment would need to win further approval from the Legislature during the upcoming session as well as voter approval in the form of a ballot referendum. B. Administrative Developments 1. Department Expands Property Tax Rent Rebate Program: Following the Court’s decision in Muscarella v. Commonwealth, 87 A.3d 966 (Pa. Commw. 2014), discussed above at III.A.1., on September 8, 2014, the Department of Revenue issued a press release indicating that beginning with claim year 2013, the Department will pay property tax and rent rebate claims filed on behalf of claimants who lived at least one day during a claim year. C. Trends and Outlook for 2015–2016 1. Property Tax Reform: Wolf repeatedly noted his proposal to decrease school district property taxes and relieve Pennsylvanians of that tax burden. This is not new either. There has been much debate regarding property tax reform. One of the big questions that remained after the last legislative session was how to replace property tax revenue because school district property taxes account for more than $13 billion of revenue annually. -7- Reed Smith LLP 2. School District Property Tax Reform: As discussed above, major school district property tax reform proposals circulated both the House and Senate last legislative session. Now, Gov. Wolf is proposing a different property tax reform where additional funds are allocated to the property tax relief fund which may be used by certain localities towards the homestead credit. IV. OTHER TAXES A. Personal Income Tax 1. Judicial Developments Limited Partners: In Wirth v. Commonwealth, the Pennsylvania Supreme Court held that Pennsylvania was not prohibited from taxing nonresident limited partners whose only connection to Pennsylvania was a minority interest in a partnership. The partnership purchased a building located in Pittsburgh, obtaining financing through a nonrecourse mortgage. The partnership business continuously produced losses which the nonresident partners could not use to offset other Pennsylvania income. Eventually, the mortgage was foreclosed. Pennsylvania took the position that the nonresident partners owed tax on their distributive share of the partnership’s discharge of indebtedness income arising from the foreclosure. The taxpayers argued: (1) the tax would violate due process because the partners had no nexus with Pennsylvania; (2) the foreclosure was not a taxable event; (3) the “tax benefit rule” prohibited tax on their discharge of indebtedness income; (4) the tax violated the Uniformity Clause of the Pennsylvania Constitution; and (5) the tax violated the federal Privilege and Immunities and Equal Protections Clauses. The court ruled against the taxpayers on all issues. Wirth v. Commonwealth, 95 A.d 822 (Pa. 2014). 2. Administrative Developments Intangible Drillings Costs: On December 2, 2013, the Department of Revenue issued guidance on how to recover intangible drilling and development costs associated with oil, gas and geothermal wells, under Act 52. Pursuant to Act 52, a person must capitalize intangible drilling and development costs (“IDCs”) and amortize those costs over a 10-year period. However, a taxpayer may elect to currently expense up to one-third of the IDCs in the tax year in which they are incurred and amortize the remaining costs. A person may expense a portion of the IDCs for personal income tax purposes without regarding to federal treatment. Informational Notice Personal Income Tax 2013-04: Intangible Drilling & Development Costs (12/2/2013). 3. Trends and Outlook for 2015–2016 Increase Personal Income Tax Rate. Wolf proposed increasing the personal income tax rate by more than 20%, from 3.07% to 3.7%. His budget estimates a $2.4 billion revenue increase from this change alone. Importantly, this increase to the personal income tax rate will impact small businesses structured as flow-through entities or sole proprietorships that pay personal income taxes on their business income. -8- Reed Smith LLP B. Bank Shares Tax 1. Legislative Developments Act 52 Includes Changes to Bank Shares Tax: The changes under Act 52 of 2013 include: A broader tax base: The Bank Shares Tax now applies to every “institution doing business in this Commonwealth.” The legislation creates a new definition of “doing business in this Commonwealth,” extending the tax to banking institutions that generate at least $100,000 of gross receipts apportioned to Pennsylvania, and solicit business in Pennsylvania; or hold a security interest, mortgage or lien in real or personal property located in Pennsylvania. A change in apportionment: Starting 2014, the Bank Shares Tax is apportioned using only the receipts factor. That is, taxpayers will now disregard the payroll and deposits factors. A change in rate: The Bank Shares Tax rate is now .89% of the book value of total bank equity capital. Market Sourcing: Like the Corporate Net Income Tax, the receipts-factor sourcing will be based on market principles. 2. Judicial Developments Supreme Court Validates Bank Shares Tax: On December 27, 2013, the Pennsylvania Supreme Court held that the statutory method for computing the Bank Shares Tax for banks engaging in merger transactions was constitutional. The Lebanon Valley constitutional challenge focused on the unique tax base for the Bank Shares Tax, which was a six-year average of a bank’s equity. More specifically, the constitutional issue involved how to compute the tax base for a bank that was involved in a merger. Under the statute, the tax base for a bank involved in a merger was computed by combining the premerger equity of the merged banks. That provision was the subject of litigation in First Union National Bank v. Commonwealth 885 A.2d 112 (Pa. Commw. Ct. 2005) almost a decade ago, and in that case the court held that the historical equity of an out-of-state bank could not be combined with that of an instate bank when the two merged. As a result of First Union, the survivor of a merger of an out-of-state bank into an in-state bank typically could end up paying less tax than an otherwise similar survivor of a merger of two instate banks. Lebanon Valley involved the merger of two instate banks. Lebanon Valley argued, under the uniformity clause of the Pennsylvania constitution, that its merger must be treated the same as the merger of an out-of-state bank into an instate bank—that is, the survivor of a merger of two instate banks must be entitled to dilute its tax base in the same manner as the survivor of a merger of an out-of-state bank into an instate bank. After lengthy litigation, the Pennsylvania Supreme Court concluded that it was permissible for the legislature to classify these two transactions differently because "[t]he merger or combination of two institutions, both previously taxed on their historic average values, is a different scenario than a combination that introduces -9- Reed Smith LLP previously untaxable assets to the calculation." As a result, the court held that the different treatment did not violate constitutional uniformity principles. The Bank Shares Tax was substantially amended effective January 1, 2014. Thus, the Lebanon Valley decision is of limited impact on a going forward basis. Lebanon Valley Farmer’s Bank v. Commonwealth, 83 A.3d 107 (Pa. 2013). 3. Administrative Developments Department of Revenue Releases Receipts Factor Notice: On April 14, 2014, the Department issued a notice intended to clarify the changes under Act 52. Under the notice, the Department instructs taxpayers with receipts from investment assets or activities to use Method 2 under the statute for determining the receipts from both trading and investment assets and activities to be included in the numerator of the receipts factor. Information Notice – Bank Shares Tax 2014-01: Bank Shares Tax Receipts Factor Apportionment (4/14/14). 4. Trends and Outlook for 2015–2016 Bank Shares Tax Rate Increase: Gov. Wolf proposed to undo part of the change made by Act 52 of 2013 and increase the bank shares tax rate from 0.89% back to 1.25%. C. Gross Receipts Tax 1. Judicial Developments Limit on Telecom Gross Receipts Tax: Several taxpayers are challenging the Department of Revenue’s broad interpretation of the telecommunications gross receipts tax in cases pending in Commonwealth Court. Verizon, the taxpayer in the lead case, argued that Bell Telephone was wrongly decided by the Pennsylvania Supreme Court in 1943. In July 2013, the court issued its decision, concluding that the Department’s interpretation went too far. Specifically, the court concluded that receipts from nonrecurring service charges are not subject to gross receipts tax, but receipts from private line and directory assistance charges are taxable. The gross receipts tax is imposed on receipts from “telephone messages transmitted” (traditional telephone messages) and receipts from “mobile telecommunications service messages” (cell phone messages). The Verizon case involved the portion of the statute imposing tax on traditional telephone messages, so the controversy focused on the meaning of the phrase “telephone messages transmitted.” Specifically, the issue was whether three distinct types of receipts are subject to tax: receipts from certain non-recurring service charges; directory assistance charges; and flat-rate charges for private lines. The statutory language at issue—“telephone messages transmitted”—has existed since 1929. And in the 1943 case of Commonwealth v. Bell Telephone Company of Pennsylvania, the Pennsylvania Supreme Court interpreted this language very broadly. Verizon argued that Bell Telephone was wrongly decided. Alternatively, Verizon argued that the receipts at issue are not taxable even under the Bell Telephone framework. The Commonwealth Court did not revisit the Bell Telephone decision itself. Instead, the court analyzed Verizon’s receipts under the framework established by Bell Telephone. - 10 - Reed Smith LLP Both parties filed appeals to the Supreme Court. The Supreme Court heard oral argument on March 10. However, the Court limited the oral argument to the issue involving the non-recurring service charges, which consists of three different charges: (i) installation of telephone lines; (ii) moves of, and changes to, telephone lines and services; and (iii) repairs of telephone lines. Verizon Pennsylvania, Inc. v. Commonwealth, Pennsylvania Supreme Court Docket No. 70 MAP 2013. D. Severance Tax and Act 13 Marcellus Shale Impact Fee 1. Judicial Developments Portions of Act 13 Declared Unconstitutional: On December 19, 2013, the Pennsylvania Supreme Court ruled that certain provisions of Act 13 are unconstitutional (Act 13 contains the 2012 amendments to the Pennsylvania Oil and Gas Act). Act 13 gave each county the power to impose a $40,000 to $60,000 flat fee—the "Impact Fee"—for a well’s first year of operation, with the amount of the fee declining over the next 15 years. The Act did not contain any refund procedures for Impact Fees paid in error. And although enacted in 2012, Act 13 also authorized a retroactive Impact Fee on all wells drilled before 2012. The Act further included zoning and setback requirements, requirements that the Robinson Township court found to be unconstitutional. Now, the Supreme Court has ordered the Commonwealth Court to determine if the unconstitutional zoning and setback provisions are "severable" from the rest of the Act. On March 13, 2014, the Commonwealth Court issued an Order directing the parties to brief specific issues which does not include the impact fee. Thus, it appears that the impact fee will survive the Court’s ruling that will follow the May 14, 2014 en banc hearing. Nevertheless, it is still possible that the impact fee will be invalidated in the pending litigation. Even if the Commonwealth Court allows the Impact Fee to remain in effect, there is still a question of whether the retroactive component of the fee violates the State and federal due process. The retroactivity issue is only relevant to fees paid on wells drilled before 2012. Robinson Township v. Commonwealth, No. 63 MAP 2012, December 19, 2013. 2. Trends and Outlook for 2015–2016 Severance Tax on Natural Gas Drilling. Gov. Wolf proposed a 5% severance tax on the “value of the natural gas extracted at the wellhead plus $.047 per thousand cubic feet of gas severed.” This means Pennsylvania would go from no severance tax to a dual “value” and “volume” based tax. The “severance tax” would replace the existing Impact Fee, which currently provides funds directly to the counties. Under Wolf’s proposal, a portion of the severance tax revenue would be distributed directly to the counties. E. Unclaimed Property 1. Legislative Developments Change in Dormancy Period Proposed: As part of his 2014-2015 budget, thenGov. Corbett signed legislation that reduces the holding period for certain - 11 - Reed Smith LLP property from 5 years to 3 years, which is expected to generate a $150-million one-time revenue increase. It also established registration requirements for non-lawyer third-party finders. Under Pennsylvania’s unclaimed property law, Pennsylvania-incorporated entities that hold certain property for the actual owners, including uncashed checks and outstanding credits, must remit that property to Pennsylvania after a period of inactivity, referred to as the dormancy period. For example, Pennsylvaniaincorporated entities must pay unidentifiable credits over to Pennsylvania after the dormancy period. Further, any vendors holding credits to Pennsylvania-based businesses must pay those credits over to Pennsylvania after the dormancy period. Once the property has been remitted, the Commonwealth is supposed to hold the property in trust for owners to claim. However, in reality, the value of the unclaimed property remitted to the Commonwealth goes directly to the General Fund as revenue. The state returns only an estimated 5 percent of the almost $2 billion of unclaimed property it holds each year. F. Local Taxes 1. Legislative Developments Safe Harbor from Local Business Privilege Taxes: On May 6, then-Governor Corbett approved Act 42, which limits a municipality’s authority to impose a local Business Privilege Tax (“BPT”). Under Act 42, a BPT may only be imposed on: taxpayers that have a “base of operations” in that taxing jurisdiction; or taxpayers that conduct business more than 15 calendar days per year in that taxing jurisdiction. In other words, Act 42 creates a safe harbor protection from tax for taxpayers conducting business 15 days or less in a taxing jurisdiction. In the event a taxpayer has a “base of operations” in one jurisdiction and also conducts business in another jurisdiction for more than 15 days, the 15-day jurisdiction takes priority—that is, amounts taxed by the 15-day jurisdiction cannot be taxed by the base-of-operations jurisdiction. The legislation is a response to the Pennsylvania Supreme Court’s 2007 decision in Rendina, Inc. v. Harrisburg and the Harrisburg School District. In Rendina, the Court held that a municipality could impose BPT on a taxpayer that lacked a permanent base of operation within the municipality. Philadelphia Community Development Corporation Contributions Credit: Philadelphia has amended its city code (Chapter 19-2600 “Business Income and Receipts Taxes”) to increase the number of businesses that may obtain a credit against business income and receipts taxes upon contributing to certain community development corporations engaged in neighborhood economic development activities in the city. The ordinance increases the number of businesses from 35 to 40 beginning with tax year 2013. Phila. Ord. 130012, eff. tax year 2013. 2. Judicial Developments Supreme Court to Rule On Granting Refunds in lieu of Credits: The Pennsylvania Supreme Court has agreed to review the Pennsylvania Commonwealth Court’s decision in City of Philadelphia v. Philadelphia Tax Review Board, et al., a decision that granted over $6 million in Philadelphia tax credits to taxpayers who filed refund claims based on federal audit changes—even though the statute of limitations for refunds had expired. - 12 - Reed Smith LLP The taxpayers timely reported and paid their 2003 and 2004 Philadelphia Business Income & Receipts Tax (“BIRT”). Then, in 2009, after the 3-year limitations period for filing a refund claim expired, the taxpayers’ 2003 and 2004 federal taxable income was reduced upon audit. The taxpayers properly filed amended BIRT returns reporting the federal audit changes. The taxpayers also petitioned for refunds of the resulting overpayments. The Philadelphia Department of Revenue refused to issue refunds because the petitions were filed after the expiration of the 3-year statute of limitations. The taxpayers appealed to the Philadelphia Tax Review Board. The Board agreed with the Department that the taxpayers’ refund petitions were untimely, but it awarded the taxpayers credits equal to the amount of tax overpaid. The Commonwealth Court affirmed the denial of the refund claims and upheld the award of credits to the taxpayers. According to the Commonwealth Court, the three-year limitations period on refunds was inapplicable to credits; unlike refunds, taxpayers could receive credits for overpayments at any time. The Commonwealth Court denied rehearing, and the city filed a Petition for Allowance of Appeal with the Pennsylvania Supreme Court. The Supreme Court agreed to hear the appeal, and briefing has already begun. City of Philadelphia v. Philadelphia Tax Review Board, et al.,97 & 98 C.D. 2013. Court Concludes That Localities May Not Impose Tax on Rental Income: On September 19, 2014, the Commonwealth Court issued a decision concluding that Lower Merion Township (“the Township”) may not impose its business privilege tax (“BPT”) on a taxpayer’s gross receipts from rental income. The Township imposes a BPT on “[e]very person engaging in a business, trade, occupation or profession in the Township” at the rate of 1.5 mills on gross receipts. This BPT is authorized under the Local Tax Enabling Act (“LTEA”); however, it is also subject to restrictions under the LTEA. One of those restrictions prohibits localities from imposing a tax on “leases or lease transaction s.” 53 P.S. § 6924.301.1(5)(1). The taxpayers owned and leased real property in the Township. The Township imposed its BPT on rental receipts from those properties. The trial court sided with the Township and found the imposition of tax permissible because the BPT is imposed on a taxpayer’s aggregate annual income/proceeds from the lease, and not on each individual lease transaction. The Commonwealth Court framed the issue as a matter of statutory construction involving an exclusion from tax. As a result, the court strictly constructed the statutory provision against the Township. Ultimately, the Commonwealth Court agreed with the taxpayers and concluded that the LTEA prohibited a locality from imposing any tax on leases or lease transactions. That is, because the BPT would be imposed on the lease revenue at a rate of 1.5 mills, it was a tax on leases in violation of the LTEA. Any taxpayer that earns revenue from leases or rentals of property and pays local BPT in Pennsylvania (not including Philadelphia taxes) should consider whether it is entitled to a refund. Court Invalidates Scranton’s Commuter Tax: On September 30, 2014, the Lackawanna County Court of Common Pleas struck down a recently enacted Scranton ordinance that imposed a .75% earned income tax solely on nonresidents. Scranton enacted the tax pursuant to the Municipal Pension Funding Standard and Recovery Act, which permits a municipality to - 13 - Reed Smith LLP increase its tax rate on earned income above maximum rates set by otherwise applicable laws. The taxpayers argued that the tax was unlawful because it was imposed exclusively on nonresidents. The court agreed. Because the Municipal Pension Funding Standard and Recovery Act was silent on the issue, the court looked to other laws governing Scranton’s taxing power: The Local Tax Enabling Act, the Home Rule Charter and Optional Plans Law, and the Municipalities Financial Recovery Act. The court found that these laws all placed limitations on Scranton’s power to tax nonresidents. The court inferred from these limitations that Scranton’s earned income tax was impermissible. The City has until October 30, 2014 to appeal the decision to the Commonwealth Court. In re City of Scranton Ordinance No. 36 of 2014, No. 2014 CIV 4799, (Sept. 30, 2014). Commonwealth Court Finds Freight-Brokerage Provider Not Public Utility: On October 15, 2014, the Commonwealth Court issued a decision concluding that a taxpayer acting as a middleman between shippers and PUC-licensed freight carriers was subject to the City of York’s (“City”) business privilege tax (“BPT”), because the taxpayer did not qualify for the “public utility service” exemption.7 The taxpayer in this case did not engage in any transportation activities itself. Rather, its business was charging shippers a fee and then negotiating for shipment by a licensed carrier and remitting shipping costs to the carrier. The City’s BPT is subject to the limitations of the LTEA, which exempts from BPT gross receipts derived from transactions involving the rendering of “public utility services.” In this case, the court concluded that the taxpayer was not engaged in rendering a public utility service because it simply “facilitates the buying of shipping services but does not, itself, transmit, deliver or furnish transportation of property – the hallmark rendering of any public utility service as a common carrier.” 3. Administrative Developments Philadelphia Sustainable Business Credit Regulation: The Philadelphia Department of Revenue has issued Business Income and Receipts Tax Regulation 505, effective March 11, 2013, to assist in administration of the sustainable business tax credit against Philadelphia business income and receipts tax. The regulation provides definitions, information on filing applications, addresses eligibility requirements and the amount of the credit. The regulations provide that businesses must apply for certification as a sustainable business on a form specified by the Mayor's office of Sustainability, and all annual certifications will be granted on a first come, first serve basis. Eligible businesses will receive a tax credit equal to $4,000 for tax years 2012 through 2017. G. Slot Machine Tax 1. Judicial Developments Supreme Court Liberally Construes Deductions from Slot Machine Tax: In Greenwood Gaming & Entertainment, Inc v. Commonwealth, the Pennsylvania Supreme Court issued a taxpayer-friendly decision interpreting the statutory provision at issue as an exclusion (interpreted in favor of the - 14 - Reed Smith LLP taxpayer) rather than an exemption (interpreted in favor of the Commonwealth). The Greenwood Gaming case involved Pennsylvania’s tax on slot machine revenue. Under the statute, the calculation of the tax base—which is called Gross Terminal Revenue (“GTR”)—starts with wagers received by a slot machine and then subtracts: amounts paid out to players as a result of playing a slot machine; amounts paid to purchase annuities to fund prizes payable to players as a result of playing; and personal property (other than comps such as travel expenses, food, refreshments, lodging, or services) distributed to players as a result of playing. Greenwood Gaming, which operates Parx Casino, argued that it should be entitled to deduct from GTR the cost of vehicles, concert tickets, sporting event tickets, and gift cards given to patrons with slot-player cards. The Commonwealth argued that the statute requires a direct, traceable connection between slot play and the personal property given to the player. According to the Commonwealth, only payouts reflected in the Department of Revenue’s central control computer system (“CCCS”)—which tracks GTR—are permitted to be deducted. And the only amounts reflected in the CCCS are those that are directly traceable to a particular instance of slot play. The Commonwealth Court ruled in favor of the Commonwealth, holding that the only payments that are deductible are those made “as a direct and immediate result of physically operating a slot machine.” The Supreme Court reversed. As noted above, the court concluded that the definition of GTR created exclusions, which are interpreted in favor of the taxpayer. As a result, the court interpreted the phrase “as the result of playing a slot machine” to mean that payments can still be deducible even if “tied more generally to slot machine play at the gaming facility,” rather than being “tied to specific machines.” As a result of this decision, a casino can now take a deduction from its tax base for the cost of promotional giveaways to slot players. The combined state and local tax rate imposed on GTR is 55%, so without this deduction, many giveaways were impractical. The case was remanded to Commonwealth Court to make a factual determination of whether the promotional items given away by Parx were tied to slot play at all. Greenwood Gaming and Entertainment, Inc. v. Commonwealth, 90 A.3d 699 (Pa. 2014). 2. Administrative Developments Department Issues Bulletin on Promotional Items: In response to Greenwood Gaming, 90 A3d 699 (Pa. 2014), on March 27, 2015, the Department of Revenue issued the attached Gaming Tax Bulletin stating the Department’s policy on the deductibility of promotional items for purposes of calculating gaming taxes. The Department limits the deduction of promotional items to a specified group of four categories of prizes awarded as the result of a slot machine or table game wager. In addition, prior to the start of the promotion, the licensed venue must give the Department electronic notice of the pending promotion. The bulletin also outlines return filing and documentation requirements. - 15 - Reed Smith LLP V. ADDITIONAL NOTES OF INTEREST A. Update on the Board of Finance and Revenue. The overhaul of the Board of Finance and Revenue became fully effective April 1, 2014. The newly structured Board consists of three members—two are appointed by the Governor (and confirmed by the Senate), and the third is the Treasurer or the Treasurer’s designee. Argument Procedure: Hearings before the new three-member Board have proved to be a meaningful opportunity for taxpayers to present issues and have them decided by an independent tax tribunal. The taxpayer presents its argument first. The Department is then permitted to present its arguments and respond to any questions the Board may have. (Lawyers from the Department of Revenue’s Office of Chief Counsel have been representing the Department at these hearings and presenting legal arguments to the Board.) The taxpayer is then given an opportunity to rebut the Department’s argument. Operating Rules: The Board released Operating Rules that set forth the procedures for the new Board. The Treasury Department initiated the formal regulation process with the Independent Regulatory Review to formalize these operating rules. The following are some important provisions of the Operating Rules. The rules, however, are flexible: they are to be liberally construed such that the Board may, at any stage of the proceeding, waive a particular requirement, including a deadline, where appropriate. Ex Parte Communication: While ex parte communications between a party and the Board’s staff are not permitted under Act 52, a party can waive its right to participate in such communications. Furthermore, where a party is given notice and an opportunity to participate, the failure of a party to participate in a communication will be deemed a waiver by that party. Communication with Board Members: The Board members may not participate in any communications with either party regarding the merits of a case, outside of the hearing. Initial Submissions: Unless a different time is provided by the Board, all submissions must be submitted to the Board no later than 60 days after the filing of the petition. Responses: The opposing party has 30 days to respond to any submission. The Board is not required to review submissions and responses filed after the prescribed deadline. Compromise: If a petitioner offers a compromise, it must submit a completed Board of Finance and Revenue Compromise Form either with the petition or within 30 days of filing the petition. For the Board to issue a compromise order, the parties must agree to waive any right to file an appeal that raises the same issues for the tax period(s) and liability(ies) addressed in the compromise order. Request for Reconsideration: A party may file a request for reconsideration of the Board’s order within 15 days of the decision. Publication or Orders: The Board is required to publish all final orders on the Internet. Prior to an order being published, the Board will redact certain confidential taxpayer information. Taxpayers are permitted to participate in the redaction process. B. Possible Change to the Uniformity Clause of the Pennsylvania Constitution: Subcommittees have been formed to review specific provisions of the Pennsylvania constitution to determine whether those provisions need to be “modernized.” One of the provisions being studied is the uniformity - 16 - Reed Smith LLP clause which provides that “all taxes shall be uniform, upon the same class of subjects…” within the same taxing jurisdiction. Because of this uniformity provision Pennsylvania cannot impose a graduated income tax rate, cannot tax residential and commercial property at different rates, and also cannot issue “spot assessments” but instead must reassess all property in a county instead of singling out specific property for reassessment. There is some concern that “modernization” of the uniformity clause may undo these taxpayer-friendly protections. C. “Pay-to-play” at the Board of Appeals? The Department has taken the position that the only issues that can be addressed by the appeal boards in a corporate net income or franchise tax assessment appeal are ones directly related to the adjustments made by the Department in its assessment. (In the past, a Pennsylvania taxpayer could raise any issue in an appeal of a "settlement," i.e., assessment.) This position can create a problem when a taxpayer agrees with the Department's adjustment, but disagrees with the overall tax assessed because other issues would reduce the amount of tax liability. Now, for a taxpayer to request an adjustment to its tax liability, the taxpayer must first pay the assessment, and then file a refund claim raising those issues that are not directly related to the assessment. Additionally, the Department is automatically dismissing refund petitions where an amount remains unpaid on the taxpayer’s account for the tax year at issue. D. Payment of Assessment Opens Appeal Period. In the case of amounts paid as the result of an assessment, determination or settlement, a petition for refund must be filed within 6 months of the actual payment of tax. Previously, a taxpayer was required to file within 6 months of the mailing date of the notice. VI. BIOGRAPHIES A. Lee A. Zoeller Lee is the Practice Group Leader of Reed Smith’s State Tax Group. He works closely with clients to determine the best course of action--from strategy development through litigation--to resolve the taxpayer’s issues. In addition to representing clients in state tax appeals, Lee also provides multistate advice to corporations on various state income, franchise and sales tax issues--and works with these corporations to implement any resulting tax-saving strategies. B. Frank J. Gallo Frank is a partner in Reed Smith’s State Tax Group. He focuses his practice on state tax planning and controversy matters, specializing in income/franchise and sales and use taxes. He advises clients in a variety of industries, with an emphasis on the pharmaceutical, financial services, and consumer product industries. C. Christine M. Hanhausen Christine is an associate in Reed Smith’s State Tax Group. She handles multi-state corporate tax and sales and use tax issues and specializes in Pennsylvania taxes. She represents clients in a widerange of industries in connection with state tax return positions, audits, administrative appeals, and litigation in various jurisdictions. - 17 - RHODE ISLAND STATE TAX DEVELOPMENTS SPRING 2015 Kirk Lyda JONES DAY 2727 North Harwood Street Dallas, TX 75201 (214) 969-5013 [email protected] http://www.jonesday.com/klyda/ Lawyerly Caveat: The views set forth herein are the personal views of the authors and do not necessarily reflect those of the law firm with which they are associated. I. CORPORATE INCOME TAX A. Overview Rhode Island imposes a corporate income tax on the net income of corporations incorporated or doing business in the state. Taxable net income is generally equal to federal taxable income, with certain additions and subtractions required by Rhode Island law. The Rhode Island budget bill signed June 19, 20141 adopted combined reporting, single sales factor apportionment, and market-based sourcing. The changes reduced the corporate income tax rate to 7%, repealed the franchise tax, and created a non-binding independent appeals process to resolve certain apportionment disputes. The changes apply to tax years beginning on or after January 1, 2015. Combined reporting is required for corporations that are directly or indirectly more than 50 percent owned by a common owner (or owners) and are engaged in a unitary business. Certain types of businesses are excluded from the combined reporting requirement. An affiliated group of corporations can generally make a five year, irrevocable election to file on a consolidated basis (in lieu of unitary combined). The prior three factor apportionment formula is replaced by a single sales factor. Sales are generally sourced using market sourcing, applying a Finnigan approach to sales by group members that lack nexus with Rhode Island. The bill contains transition rules for net operating losses and credits from tax years prior to January 1, 2015. In mid-2014, the Taxation Division issued a draft regulation and statement of principles interpreting the above legislative changes. Comments were originally due in December 2014 but were being accepted after that date. The full text of these documents is available on the Tax Division’s website at http://www.tax.ri.gov/Tax%20Website/TAX/combinedreporting/ B. Legislative Developments 1. 2014 Legislative Session See discussion of the major changes made by House Bill 7133 above. 1 Rhode Island House Bill 7133. DLI-266523941v1 2. 2013 Budget Bill The 2013 Rhode Island budget bill (House Bill 5127) made a number of corporate income tax changes. Effective January 1, 2014 (for assets placed in service after 2013), assets may be expensed as provided in IRC § 179. Effective for tax years beginning after 2013, taxpayers are required to add back domestic production activity deductions claimed under IRC § 199. Effective July 3, 2013 taxpayers may claim a historic rehabilitation credit against the corporate income tax for a certain percentage of qualifying rehabilitation expenditures for the substantial rehabilitation of a certified historic structure, subject to limitations. Also effective July 3, 2013, the total credit for certain contributions to scholarship organizations is increased to $1.5 million (up from $1 million). C. Administrative Developments 1. Administrative Decisions Now Available Online The Tax Division has started posting copies of administrative decisions online at: http://www.tax.ri.gov/AdministrativeDecisions/ Currently, administrative decisions for 2011, 2012, 2013, and 2014 are online. 2. Rhode Island Ruling Request No. 2011-04 (February 16, 2011) – Company’s President Who Had Check-Writing Authority and Also Signed Returns Is Considered a Responsible Officer for Withholding Tax Purposes Ruling No. 2011-04 addresses corporate responsible officer liability in the context of personal income tax withholding. Given the dearth of responsible officer authority in Rhode Island, however, the implications of the approach taken in this ruling should be considered more broadly.2 After learning that the company in question was in bankruptcy, the Division of Taxation initiated a review of the company’s records. Following its review, the Division issued an estimated assessment for unpaid withholding tax. A corresponding assessment was also issued against the company’s president as a responsible officer. Under R.I. Gen. Laws § 44-30-76, every employer, including every officer and employee of a corporation who is under a duty to deduct and withhold Rhode Island personal income tax, is liable for paying the withholding tax. Based on a reading of federal case law―Fiataruolo v. U.S., 8 F.3d 930 (2d Cir. 1993)―the hearing officer concluded that the inquiry into potential responsible officer liability focused on whether an individual could have exerted influence over the business. The hearing officer cited a “number of factors” that are considered in making this determination, no one of which is determinative. These factors include whether the person: (1) is an officer or board member; (2) has an ownership interest; (3) is active in day-to-day affairs; (4) has the ability to hire and fire employees; (5) makes decisions regarding payment of debts or taxes; (6) controls bank accounts and records; and (7) has check-signing authority. On the basis of the record (the officer in question did not appear at the hearing), the hearing officer concluded that as the president of the company, who signed checks and tax returns on behalf of the company, the officer had responsibility to withhold and remit the tax. 3. Adoption of Regulations Regarding the Exclusion of Distributive Share of Public Service Income Regulation CT 10-12, effective January 1, 2011, implements R.I. Gen. Laws § 44-11-12(2) allowing a deduction of the distributive share of the taxable income of a public service corporation liable for the public service corporation tax. The regulations provide the following examples: 2 See discussion of Hearing Decision No. 2011-03. DLI-266523941v1 2 Example 1: A utility company sells tangible, intangible or real property not devoted to its utility operation. Such net gain distribution is a taxable transaction for Chapter 13 [Public Service Corporation Tax] purposes and therefore is excludable for Chapter 11 [Business Corporation Tax] purposes. Example 2: A utility company sells tangible, intangible or real property devoted to its utility operation. Such net gain distribution is a nontaxable transaction for Chapter 13 [Public Service Corporation Tax] purposes and therefore is not excludable for Chapter 11 [Business Corporation Tax] purposes. D. Trends/Outlook for 2015/2016 1. Combined Reporting In our update for Spring 2014, we advised that the adoption of mandatory combined reporting remained a serious threat in Rhode Island. After years of studying the issue, including requiring pro forma combined reports, Rhode Island has now joined the growing number of combined reporting states. As we have seen with other states that have recently adopted combined reporting, important policies and procedures will be analyzed and implemented in the months and years to come. It will be important for companies engaging in business in Rhode Island to follow and perhaps play a role in shaping those policies and procedures. The regulation implementing these important changes is being developed. II. SALES AND USE TAX A. Overview The Rhode Island sales tax is imposed at the rate of 7 percent of gross receipts from retail sales of tangible personal property, as well as certain specified services, telecommunication charges, accommodations, and other enumerated items. The tax is imposed on consumers but is collected by retailers. A complementary use tax is imposed on the storage, use, or other consumption of taxable property in the state. No Rhode Island localities are authorized to charge a sales or use tax. Rhode Island adopted the Streamlined Sales and Use Tax Agreement effective January 1, 2007, and is a member of the Governing Board. The state’s taxability matrix, which outlines how the state treats the library of definitions from the agreement and how certain products are taxed, is available at http://www.tax.state.ri.us/streamlined. B. Legislative Developments 1. 2014 Legislative Session No significant sales tax changes were made. 2. 2013 Budget Bill The 2013 Rhode Island budget bill (House Bill 5127) made a number of sales tax changes. The new law would require sellers to collect sales or use tax on “remote sales,” if such a requirement is authorized by a change in federal law. The new law would make certain changes to the sales tax rates and tax base contingent on the passage of such federal legislation. The legislation also created a special commission to conduct a comprehensive study of the state sales tax. 3. 2012 Sales Tax Changes Effective October 1, 2012, the sales tax applies to: Taxi, limousine, and intrastate charter bus services Pet care services DLI-266523941v1 3 Effective July 1, 2012, the former tax on tour and sightseeing transportation services was repealed. Effective October 1, 2012, the clothing and footwear exemption is capped at $250 (the tax applies to these items if and to the extent the sales price is greater than $250). 4. Contingent Rate Changes In the event a federal law is enacted requiring remote sellers to collect and remit state sales taxes, Rhode Island will change its sales-type taxes as follows: The 7 percent sales and use tax rate would drop to 6.5 percent. The 1 percent local meals and beverage tax would increase to 1.5 percent. The 1 percent local hotel tax would increase to 1.5 percent. C. Administrative Developments 1. Administrative Decisions Now Available Online The Tax Division has started posting copies of administrative decisions online at: http://www.tax.ri.gov/AdministrativeDecisions/ Currently, administrative decisions for 2011, 2012, 2013, and 2014 are online. 2. items. New Commercial Farming and Related Items Regulation SU 14-153 The Tax Division adopted the above regulation and repealed several prior regulations related to farming 3. New Streamlined Sales Tax Regulation SST 13-01 Effective May 1, 2013, the Tax Division adopted new Regulation SST 13-01 in an effort to reflect the current language in the streamlined sales tax agreement regarding direct mail. 4. New Retailer Record Keeping Regulation SU 13-91 Effective May 1, 2013, the Tax Division adopted a new Regulation SU 13-91 related to record keeping requirements applicable to retailers. The Tax Division intended to tighten the record keeping requirements. 5. Regulations Implementing The 2012 Legislative Changes Generally effective October 1, 2012, the Tax Division adopted new regulations implementing the legislative changes for taxi and limousine services (SU 12-151), pet services (SU 12-152), and the clothing and footwear exemption (SU 12-13). 6. Rhode Island Admin. Hearing Decision No. 2012-11 – Refund claim denied for sales tax paid on computer software system being used in contract with the Navy. In this hearing, the Tax Division denied the taxpayer’s refund claim for sales tax paid on software being used to perform a contract with the Navy. The manufacturing exemption applies to the manufacturing of tangible personal property for sale. Under the Rhode Island statutes, tangible personal property includes prewritten (canned) computer software. The ALJ found that the software in question was not prewritten computer software. DLI-266523941v1 4 7. Rhode Island Admin. Hearing Decision No. 2012-04 – Asphalt manufacturer held liable for tax to extent asphalt was manufactured for the taxpayer’s own use. In this hearing, the Tax Division held an asphalt manufacturer liable for sales tax because 58% of the asphalt was manufactured for the taxpayer’s own use. 8. Rhode Island Admin. Hearing Decision No. 2011-12 – Used-Car Dealer Liable For Use Tax On Use Of Truck The Tax Division recently held that a used car dealer was liable for use tax on a new truck purchased and sold several weeks later. The taxpayer argued that the truck was part of the dealer’s inventory, and only used for demonstration and advertising purposes. The Tax Division showed that the truck was purchased using personal funds and driven about 2,500 miles. The Hearing Officer held that use tax applied. III. PROPERTY TAX A. Overview Unless specifically exempted, real property within the State of Rhode Island is subject to ad valorem taxation. Property taxes in Rhode Island are levied by the city or town where the taxpayer either is domiciled or has property located. All real and tangible personal property is assessed as of midnight on December 31. Real and tangible personal property is taxed at rates determined by the various municipalities. Intangible property is not subject to ad valorem taxation, with the exception of certain utility-owned and credit union property. B. Legislative Developments 1. 2014 Legislative Session No significant changes were made to the property tax. 2. 2013 Legislation The 2013 legislature enacted a number of property tax provisions. These provisions dealt with a number of classification and exemption issues applicable to particular localities. C. Judicial Developments UTGR, Inc. v. Mandillo, PC-08-2614, PC-101172 (R.I. Superior Court, April 26, 2011) – Town’s Valuation of Improvements Failed to Reflect the Full and Fair Value of the Property The superior court held that a town’s tax assessment needed to be adjusted because the valuation of improvements did not reflect the full and fair value of the property. The taxpayer, UTGR, owns and operates a racino, considered a special-use property, under a video lottery and gaming entertainment license. Originally operated as a race track, first for horses and then for dogs, the facility eventually discontinued live racing. In addition to the casino space, the facility also currently consists of limited restaurant and entertainment amenities and a large parking lot. Under its contract with the state, UTGR undertook renovations at the facility that increased the casino space, converted a portion of the existing space to back-of-the-house space, and included removal of the large concrete grandstands previously used for racing. The court upheld the town’s raw land valuation portion of the appraisal. After considering competing expert testimony, the court concluded that the analysis of the taxpayer’s expert lacked credibility because the expert failed to include the value of other commercial land in the town, subjectively selected comparable sales of destination casinos in other states, and did not adjust for variations in market conditions. Despite noting problems with the town’s valuation methods, the court held that the taxpayer failed to carry its burden of proving the proper valuation of the land. DLI-266523941v1 5 The court did, however, accept the taxpayer’s valuation of the improvements. The court found, in part, that the town failed to properly account for the functional obsolescence of several aspects of the improvements (e.g., the unused concrete grandstands and food court areas), that the taxpayer’s expert more accurately computed the percentage of completion of ongoing renovations, and that the town overstated the square footage in its per-squarefoot cost analysis by considering a hypothetical identical building rather than just the functional space. IV. BIOGRAPHIES Kirk Lyda, partner, attorney and CPA, concentrates his practice on state tax litigation, controversies, and planning. His experience includes representing taxpayers in cases such as Rylander v. Bandag Licensing Corp., 18 S.W.3d 296 (Tex. App.–Austin 2000, pet. denied) (declaring the Texas franchise tax unconstitutional as applied to a foreign corporation without any substantial physical presence in the state and awarding attorneys’ fees to the taxpayer), and Rylander v. Fisher Controls Int’l, 45 S.W.3d 291 (Tex. App.–Austin 2001, no pet.) (holding that the Texas Comptroller violated the Texas Tax Code’s “throwback rule” for purposes of Texas franchise tax apportionment). He assisted in the representation of the taxpayers in Sharp v. Park ’N Fly of Texas, Inc., 969 S.W.2d 572 (Tex. App.–Austin 1998, pet. denied) (Texas sales tax lawsuit), and Nabisco, Inc. v. Rylander, 992 S.W.2d 678 (Tex. App.–Austin 1999, pet. denied) (Texas franchise tax lawsuit). He has represented taxpayers in numerous Texas franchise tax and Texas sales tax hearings before the Texas Comptroller of Public Accounts. More recently, Kirk has represented taxpayers with intangible property management company tax cases pending before the courts or administrative agencies of Maryland, Massachusetts, and North Carolina. He has extensive experience representing major online travel service companies in tax controversies and litigation and in related transactional and legislative work. He has advised clients on the state tax implications of restructuring their business operations throughout the United States. Kirk has spoken at seminars and conferences throughout Texas and in other states on a variety of state tax topics. He also coauthored Accounting and Finance for Lawyers, a Harcourt publication, and Business Purpose: What Is It? How Much Is Enough?, a 2004 publication of the New York University Institute on State and Local Taxation. Admitted: Texas Education: The University of Texas at Austin (J.D. 1999; M.P.A. 1996; B.B.A. 1996) CAVEAT: Please consult your tax advisor on your specific facts. This outline does not offer, nor is it intended to offer, legal advice. IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. DLI-266523941v1 6 VERMONT STATE DEVELOPMENTS KATHRYN H. MICHAELIS WILLIAM F. J. ARDINGER CHRISTOPHER J. SULLIVAN STAN ARNOLD Rath, Young and Pignatelli, P.C. One Capital Plaza Concord, NH 03301 Phone: 603.226.2600 E-Mail: [email protected] [email protected] [email protected] [email protected] Web Site: www.rathlaw.com I. INCOME/FRANCHISE TAXES A. Legislative Developments 1. Tax Havens Hitting the Radar in Vermont. Piggy-backing on the national movement on the “tax haven” front - including legislative action in New Hampshire this session - the Vermont legislature is considering a more conservative approach with a proposal for the Commissioner of Taxes to report to the legislature on or before January 15, 2016 with a recommendation as to how to “include income from tax havens in the calculation of Vermont’s corporate income tax.” (H. 489, As Introduced). US Senator Bernie Sanders (VT) is a staunch supporter of the Corporate Tax Fairness Act, the federal legislation aimed at ending offshore tax havens. Should New Hampshire’s legislature enact the tax haven legislation currently being considered, it is likely Vermont will follow suit in a similar fashion by 2016. 2. Consolidated Return Election Binding for Five Years. The 2014 miscellaneous tax bill, supported by the Governor’s administration, made the election to file a consolidated return binding for a five-year period, including the year the election is made. Previously, Vermont permitted a consolidated election for Vermont-nexus corporations that file as part of the same federal consolidated income tax return, but did not require consistent filing from year to year. The change took effect January 1, 2014 and applies for “the tax year 2014.” The 5-year rule was supported by VDOT to prevent corporations from reconfiguring the filing group from year to year to minimize taxes in a way that does not fairly represent the group’s ability to pay. The proposal was projected to be revenue-positive. (H 884, Act 174; 32 V.S.A. § 5862(c)) 3. Reduction to Research and Development Credit Enacted. The 2014 miscellaneous tax bill reduced the R&D credit from 30% to 27% of the federal credit. The reduction took effect retroactively to January 1, 2014 and will apply to any application or claims for credits filed after that date, regardless of the tax year for which the credit was sought. In addition, the legislation requires the VDOT to disclose which companies were approved for the credit. (H 884, Act 174; 32 VSA § 5930ii) 4. Federal Conformity Updated. The federal income tax code as in effect for taxable year 2013 was adopted in the 2015 session for purposes of computing Vermont corporate income tax liability, effective retroactively to January 1, 2014 and applicable to taxable years beginning on or after January 1, 2013. (H 884, Act 174; 32 VSA § 5824). The 2015 legislation similarly proposes to update the adoption to 2014. (H. 272, S. 17). 5. VDOT Administrative Provisions Applicable to Franchise Tax. 2015 legislation proposes to make the VDOT administrative provisions applicable to corporate franchise taxes, including those provisions relating to assessments, refunds, interest, penalties, appeals and collection. (H. 272, S. 36). 1 6. B. New 1099 Filing for Credit Card Processers Required. Credit card processers are now required to file a copy of any 1099 with VDOT that was filed with the IRS within 30 days. (H 844, Act 174; 32 VSA § 5862d) Judicial Developments 1. Vermont Supreme Court To Issue First Unitary Decision Soon. Oral arguments were recently heard before the Vermont Supreme Court on the first reported unitary business case in Vermont. The case was on appeal from the Washington Civil Division of the Vermont Superior Court, which held that a subsidiary ski resort was not unitary with its insurance and financial parent group, overturning the Department’s administrative hearing decision. The Superior Court addressed two fundamental issues, the first of which was whether a subsidiary company that operated a Vermont ski resort, Stowe Mountain Resort (“MMC” or “Stowe”), was a member of the unitary business group of its parent (AIG) for the tax year 2006, the first year Vermont required combined unitary filings. The VDOT hearing officer held that MMC was unitary with the AIG unitary group for numerous reasons, including the facts that: MMC was included in the AIG combined return in all other unitary states; AIG was actively involved in the financial operations of MMC; AIG supported MMC with non-arm’s length financing; AIG provided numerous corporate services to MMC; and AIG retained authority over all of MMC’s capital and borrowing decisions. The Superior Court rejected the findings of the VDOT hearing officer, with a somewhat scathing commentary on the lack of VDOT’s evidentiary basis, stating that the VDOT’s findings “far outrun the evidence, which unambiguously shows that Stowe was a discrete business…” The Court further noted that the only relevant witnesses were those provided by AIG. The Court acknowledged the findings of intercompany transactions and flows of value between AIG and Stowe – including certain employee benefits, corporate services and financing – but found them “insufficient” to demonstrate a unitary relationship. Rather, the Court found that AIG’s evidence reflected its passive investment in a discrete business in Vermont. The second issue addressed by the court was whether the VDOT’s February 4, 2011 assessment for the 2006 tax year was barred by the three-year statute of limitations. AIG timely filed its 2006 return on extension on October 15, 2007, and filed an amended 2006 tax return excluding MMC from the unitary group on March 25, 2009. The Vermont statute provides that the VDOT may issue an assessment “at any time within three years after the date that tax liability was originally required to be paid…” and that “[i]f the taxpayer fails to file a proper return with respect to any tax liability” the assessment may be made at any time before the end of three years after the taxpayer files such a return. 32 V.S.A. § 5882. AIG asserted that the 2011 assessment was barred because the three-year statute of limitations period expired in 2010 (three years from when the original return was filed, in October of 2007). VDOT asserted that the 2011 assessment was timely because the October 2007 original return was not a “proper return,” and therefore, VDOT had three years from the March 25, 2009 amended return in which to assess AIG. The Vermont hearing officer agreed with VDOT, stating that when AIG filed its 2009 amended return with corrections and adjustments, the provisions of § 5882 allowed for a period of three years from that return for VDOT to issue an assessment. The hearing officer noted that Vermont’s statutory wording differs from any other state by allowing an additional three years if the taxpayer “fails to file a proper return.” The Superior Court upheld this portion of the VDOT decision, stating that the filing of an amended return that gives the VDOT a full picture of the taxpayer’s liability is a proper return that “restarts” the threeyear statute of limitations. The VDOT appealed the Superior Court decision to the Vermont Supreme Court, where oral arguments were recently made. A decision should be issued by mid-2015. The case is significant for two reasons: (1) it is the first unitary decision reported and on appeal in Vermont; and (2) if the Superior Court analysis is upheld on appeal, Vermont’s first decision interpreting its unitary business law places Vermont on the spectrum of states that adopt a 2 more narrowly-drawn definition of the unitary business principle. See AIG Insurance Management Services v. Vermont Department of Taxes, Superior Court, Washington Civil Division, Docket No. 589-9-13 Wncv (July 30, 2014) (on appeal to Vermont Supreme Court). C. Administrative Developments No recent developments. II. TRANSACTIONAL TAXES A. Legislative Developments 1. Miscellaneous Sales and Use Tax Revisions Made in 2014. Several minor changes were made to the sale and use tax provisions in the 2014 enacted legislation, some of which include: a. b. c. d. B. 2. Imposition of Use Tax on Telecommunications Services. The 2014 miscellaneous tax bill imposed the 6% use tax on “every person” for telecommunications services “for the use within this State.” Certain exclusions apply. The legislature has stated that the proposal was necessary because the provision of telecommunications services can be provided remotely through services such as Voice Over Internet Protocol (VOIP), and the state recognizes that it cannot require collection of sales tax on transactions with VOIP providers that do not have nexus with the state. The stated purpose of the amendment was to ensure that all Vermont recipients of telecom services are taxed equally and to provide a level playing field for Vermont providers. The proposal was projected to be revenue-neutral. (H 884, Act 174; 32 VSA § 9773)) 3. Taxes on Propane Gas Amended. Effective July 1, 2014, propane sold at retail in freestanding containers is subject to the 5% sales tax, but not the Fuel Gross Receipts Tax. (See 33 VSA 2503 ad 32 VSA 9741(26) Judicial Developments 1. C. Redefining the definition of a “retail sale” to include sales to contractors, subcontractors, or repair persons of materials and supplies for use by them in erecting structures or modifying real property. Redefining “tangible personal property” to include property used to improve, alter or repair real property by a business who is primarily engaged in the business of making retail sales of tangible personal property. Revising the direct payment permit provisions. Revising sales provisions regarding “compost” - creation of an exemption from sales and use tax for clean high carbon bulking agents and compost. (H 884, Act 174; 32 VSA §§ 9701, 9771, 9745, 9701, 9741) Vermont and City of Burlington Announce Action Against Online Travel Companies. In 2014, the State of Vermont and the City of Burlington publicly announced their intent to pursue imposition of their respective meals and rooms tax on online travel companies. Burlington imposes a local option tax in addition to the state-level tax. Outside contingency fee counsel has been hired to pursue these claims, despite the fact that governmental agencies have been losing the majority of similar claims across the country. See “Burlington seeks to squeeze online travel companies for unpaid taxes,” April Burbank, Burlington Free Press (March 24, 2014). Administrative Developments 3 III. 1. Cloud Computing Regulations Unofficially on Hold by VDOT. Due to the expiration of the legislative moratorium on collection of sales tax on prewritten software accessed remotely, effective June 30, 2013, Vermont taxes certain “cloud computing” transactions. On June 13, 2013, the VDOT issued a Fact Sheet addressing what transactions it considered taxable, which substantially mirrored the Massachusetts provisions. The VDOT has withdrawn the Fact Sheet and was making efforts to draft regulations addressing taxation of cloud computing transactions. The VDOT has been struggling to define key issues and the scope of taxation in the regulations, seeking the input of industry and practitioners over the summer and fall of 2014. Because the cloud legislation was aimed at filling a $3 million budget hole and the state is heading into a tough budget year, it is questionable whether moratorium legislation will resurface. In the meantime, the draft regulations appear to be unofficially on hold. 2. Sales and Use Tax on Contractors, Manufacturers and Retailers Clarified. On March 31, 2014, the VDOT issued a “Fact Sheet” addressing the imposition of the sales and use tax on products used by contractors and professionals making improvements to real property. Issues addressed include taxation of mark-ups, built-ins, online memberships, border issues and option taxes. Contractors and Use Tax: FAQs, Vermont Department of Taxes (March 31, 2014). In addition, on July 1, 2014, the VDOT issued another “Fact Sheet” addressing the imposition of the sales and use tax by manufacturers, retailers and contractors of items permanently installed in a home or business. Vermont Sales Tax for Manufacturers, Retailers & Contractors of Items Permanently Installed in a Home or Business, Vermont Department of Taxes (July 1, 2014). OTHER TAXES A. Legislative Developments 1. 2015 Miscellaneous Tax Proposals. As Vermont continues to struggle with implementation of its healthcare system, the legislature is examining ways to fund the system through the creation of new taxes. The healthcare bill that is currently being addressed currently includes tax proposals for two new taxes: A $0.02 per ounce excise tax on “sugar-sweetened beverages” and “syrup and powder” sold in Vermont. The proposed tax would be imposed on every “distributor” and collected as part of the retail price. A “health care payroll tax,” imposed on every Vermont employer equal to .3% of all wages paid by the employer. As originally proposed (at a higher rate), the proposed payroll tax was estimated to generate an additional $41 million in revenue. (H. 481, As Introduced) 2. Property Transfer Tax Rate Increase Proposed. As part of a water quality bill targeted at cleaning up Lake Champlain, a 0.2% increase in the property transfer tax is being considered. (H. 35, As Introduced) 3. Solar Capacity Tax Revisions Made. In the 2014 session, revisions were made to the Solar Capacity Tax as applicable to renewable energy plants, specifically, the method of valuation. In addition, the meaning of a “renewable energy” was redefined. (H 884, Act 174; 32 VSA §§ 2802(17), 3481(1)(D), 3845) 4. Miscellaneous Cigarette and Tobacco Tax Changes Made. Changes to numerous technical and definitional sections in the cigarette and tobacco tax provisions were made in the 2014 miscellaneous tax bill, including increases to the rates and changing report filing deadlines. (H 884, Act 174; 32 VSA §§ 7771, 7811,7814). In addition, the tax statutes were amended relating to “licensed wholesale dealers” and to clarify the types of tobacco products subject to tax. (H 71, Act 14) 5. Amendments Relating to Solar Energy Plants Enacted. Numerous changes were made to the property tax and uniform capacity tax relating to solar energy plants in 2014, including: a 4 blanket exemption for certain smaller solar energy plants from both the education and municipal property tax; implementing a process for fair market valuation; and increasing the current exemption from the capacity tax. (H 884, Act. 174) C. 6. Gas and Diesel Tax Amendments Increase Tax and Assessments. The 2014 transportation bill increased the tax on diesel, and imposed a new 2% motor fuel assessment on the adjusted retail price of gasoline. The effective dates vary. (H 510, Act 12) 7. Tax Rates on Spirituous Liquor Changed. The tax rates on spirituous liquor in Vermont were changed in 2014 as follows: 5% if the seller’s gross revenue is $500,000 or lower; $25,000 plus 10% of gross revenues over $500,000, if the seller’s gross revenue is between $500,000 and $750,000; 25% if the seller’s gross revenue is over $750,000. Additional changes were made to the retail sales of liquor made by a manufacturer/rectifier at a “fourth class” or farmer’s market location. (H 884, Act 174; 7 VSA § 422) 8. Credit for Reinsurance Allowed. Legislation was enacted, effective May 9, 2014, that permits domestic insurance companies to take credit for insurance on its annual statement that is ceded to a certified reinsurer domiciled in another country without requiring the certified reinsurer to maintain 100 percent security for the risk ceded. (H 260, Act 121) Administrative Developments 1. IV. Unclaimed Property Initiatives Stepping Up. The State has indicated its intention to step up efforts in unclaimed property audits, also seeking to add new audit staff and engaging outside auditors. Vermont delegates are also actively involved in the ULC efforts at drafting revisions to the model act. 2014 / 2015 TRENDS A. Tax Reform Remains on the Table Going into 2015, A January 2015 report to the JFO reflects a disappointing start to Vermont’s FY2015, with net changes in total revenues slightly negative. Corporate tax receipts were reported to have exceeded targets due to some “one time” events that are not expected to continue. Other tax revenue continues to lag as Vermont comes out of a slow economy. As a result, as Vermont continues to struggle to fill its estimated budget gap of $93 million and has underperforming tax revenue, both the Governor and the legislature are looking to a combination of cost-cutting measures within state government as well as rate increases and new taxes as reflected in this report. B. Direct Tax Appeals to Supreme Court Proposed. As part of a cost-saving measure, a bill is being introduced to the Committee on the Judiciary that proposes to require appeals of VDOT hearing decisions to be made directly to the Vermont Supreme Court. (Draft unnumbered bill 3/10/2015, as Introduced) Currently, VDOT hearing decisions are appealed directly to the Vermont Superior Court (trial court), with any appeal following directly to the Vermont Supreme Court (Vermont has no appellate court). The bill is expected to prompt the input of Vermont tax practitioners. C. Taxing “the Cloud” Still Up in the Air. VDOT struggles to draft regulations defining the scope of “cloud computing,” as discussed above. Whether renewed legislative efforts resurface again this session is unclear. Vermont is heavily influenced by other state actions in this area, including Massachusetts. And, the Governor and several in-state companies burdened by the resulting use tax are in favor of extension of the moratorium. As of now, VDOT’s regulatory efforts are unofficially on hold and it is expected that audits of “cloud issues” will not be aggressively pursued unless clearly falling within the statute. D. Effective Date of “Amazon Nexus” in Potential Limbo. As we reported in 2011 and 2012, Vermont joined the growing number of states attempting to impose sales tax on remote sellers based upon “click-through nexus” provisions. Under the Vermont provisions, a remote seller making taxable sales is presumed to be soliciting business through an “independent contractor, agent, or other representative” if the retailer enters into an agreement with a Vermont “resident” under which the 5 resident, for a commission or other consideration, directly or indirectly refers potential customers, “whether by a link on an Internet website or otherwise” to the retailer. (Act No. 45, s. 36a, Laws 2011) In an unusual step, Vermont’s click-through nexus provisions did not take effect until the date on which, “through legislation, rule, agreement, or other binding means,” 15 or more other states have adopted requirements that are “the same, substantially similar, or significantly comparable to the requirements” in Vermont’s statute as determined by the Attorney General. (Act No. 45, § 37(13), Laws 2011). This delayed effective date was believed to ensure that Vermont will not be the state at the forefront in litigation with regard to click-through nexus legislation. As more states have adopted Amazon requirements since 2011,Vermont is now faced with the possibility of having to make its law effective in the near future. A 2015 legislative initiative - backed by the Governor after Amazon was reported to have cut advertising contacts with Vermont online companies proposed to change the effective date from after enactment by 15 states to enactment by 25 states. For Tax Commissioner Peterson’s January 7, 2015 statement, see www.state.vt.us/tax. V. E. Economic Development Initiatives Underway. In the 2014 session, the Governor supported multifaceted legislation providing support for start-up, expansion and retention of companies in Vermont, particularly focusing on the high-tech sector. In addition, the VDOT, Vermont Secretary of State, Department of Labor, Attorney General and other agencies are in the process of developing a web portal for all business registrations and informational material. The portal is targeted to go “live” by June 30, 2015 and is part of Vermont’s overall effort to further economic development within the state. (S 220, Act 199) F. Taxpayer Delinquent List Went Live. The legislature authorized the Tax Commissioner to publish a list of the top 100 delinquent individual taxpayers and top 100 delinquent business taxpayers. The list was first published in early 2015. (H 884, Act 174; 32 VSA § 3102(m)) G. Tax Expenditure Purpose Statements Required. As part of its push for transparency, Vermont enacted legislation requiring that the statutory purpose for each of the tax expenditures listed in the tax expenditure report that was required under 32 VSA § 312 be placed into the statutes. (S 221, Act 200). PROVIDERS’ BRIEF BIOGRAPHY/RESUME Kathryn H. Michaelis (B.A. Kenyon College, 1993; J.D., DePaul University College of Law, 1996; LL.M., in Taxation, DePaul University College of Law, 2000) is a Shareholder with the Tax Practice Group of Rath, Young and Pignatelli, P.C., and was formerly with PricewaterhouseCoopers LLP and the Illinois Department of Revenue in Chicago. Kathryn is admitted to practice in Vermont, New Hampshire and Illinois and currently serves as a member of the Vermont Tax Advisory Board with Tax Commissioner Mary Peterson. William F.J. Ardinger (B.A., University of New Hampshire, 1982; J.D., Harvard University, 1985) is the Director of the Tax Practice Group at the Concord, N.H. law firm of Rath, Young and Pignatelli, P.C. Bill is admitted to practice in Vermont. Christopher J. Sullivan (B.A., Harvard College, 1989; J.D., Georgetown University Law Center, 1996) is a shareholder and tax attorney with a particular focus on state tax matters at Rath, Young and Pignatelli, P.C. Chris is admitted to practice in Vermont. Stanley R. Arnold (B.S., Cameron University, 1974; M.B.A., Plymouth State College, 1982) is Senior Tax Policy Advisor with the Tax Practice Group of Rath, Young and Pignatelli, P.C. and served for 14 years as the Commissioner of the New Hampshire Department of Revenue Administration. 6
